The US Presidential election resulted in a strong win for President Obama BUT the Congress remained in Republican control so the status quo of a split legislature remains.
The US political system was designed by their “Founding Fathers” to ensure that unlike the UK, no one entity or person (President, Prime Minister or King) had the power to impose laws on the people (no taxation without representation), the parliament (Congress) and the Lords (Senate) were given the right of veto (as was and is the President) this created true democracy but consequentially allowed any of those bodies to block or castrate policies.
It is hard to argue that less democracy would be a good thing but it is also hard to believe that the current situation does not validate the comment by Churchill that Democratic rule is the least bad option of all the bad options.
What is the fiscal cliff?
The US has been running budget deficits for decades and post 2008 the numbers have become gargantuan. A Sovereign budget deficit is simply the same as an individual household spending more than it earns and financing it by borrowing the shortfall.
This is not in the case of a household or individual person sustainable long-term, quickly they come bankrupt.
The key difference with a Country (Sovereign) is that they have a currency printing press so they print more money to finance debt repayments.
The effect of this however is that the value of their currency is diminished and their credit rating downgraded (so the interest rate charged on new debt goes up, making debt repayments more expensive thus requiring the printing of more money) but they can continue doing this for a very considerable time.
The US numbers
The US Government receives currently about 17 – 18% of GDP in tax revenues and has expenditures of 25 – 26% of GDP, so there is a gap of 8 – 9%.
There is therefore an urgent need to close this, to bring down expenditures and increase tax revenues, the “Bowles Simpson” plan recommended that entitlements / expenditure be reduced to around 22% and tax revenues increased by 20%, requiring the Democrats to agree to benefit cuts (they said no!) and Republicans to agree to tax increases (also no!)
(The expenditure can be higher than tax revenue because inflation means the net debt burden remains roughly par in real terms).
Politics and the art of the possible
It was disappointing but understandable that neither party would agree to the “Bowles Simpson” plan in the year before a General election.
Post the election however further politicing at the expense of the greater good is no longer an option.
Both parties will have to give ground and accept that they cannot and will not get all they want, there must be compromises on all sides.
The worries surrounding the Fiscal Cliff have resulted in markets “selling off” post the Presidential election.
The ebb and flow of sentiment and emotion is always part of markets and is why they are not efficient valuation machines over short periods.
“In the short term markets are voting machines, only over the longer term are they weighing machines.”
The short term volatility however provides wonderful opportunities for long term investors.
One of the great companies currently is undoubtedly Apple.
Its share price several months ago was $705 which for a company growing at 20% plus with $120 billion of cash on the balance sheet and a P/E ratio in the mid-teens was not demanding.
Two weeks ago the shares had fallen to $505 (a fall of around 30%) and the fundamental reasons for this decline, well there were none!
The Badger is now the proud owner of a lot more Apple shares, thank you Mr Market for your illogical short behaviour, much appreciated (as have Apple shares since).
Post 2008 everyone realised that the preceding period had not been a “Goldilocks” era (the economy neither being too hot or too cold) but rather the precursor to “Skyfall”.
Where prior to 2008 everyone blithely believed that it would all be ok, the belief in 2012 is that everything is broken and will remain forever broken.
In a sense this is the fundamentalist (black or white) thinking that has been at the heart of the US political impasse, namely the belief that either all tax increases are bad or all entitlement cuts are wrong.
The reality (as usual it is grey and requires understanding and compromise) is that although painful, countries and economies are finally grappling with the core issues that have been assiduously ducked for decades.
Entitlement promises were made in the 1940’s and 1950’s which because of changes in human longevity and advances in healthcare cannot now be afforded (this is a fact).
That the richer members of society should be asked (and should be willing) to contribute in reasonable proportion to the general running costs of a civilised society (The Buffet Rule).
That it is central to a civilised 21st Century Society that it protects the weak and the disadvantaged but that the system cannot and should not be allowed to be abused by those who seek to “game it” (i.e. a safety net but not a free lunch).
The Fiscal cliff will be sorted out just as Europe will find solutions to its problems, everyone knows the problems, nobody wins if they are not remedied, everyone’s self-interest is served by finding answers.
To paraphrase Mark Twain:
It’s not the things you are not sure about that get you in trouble.
Rather its those things you know absolutely to be right that are in actuality just plain wrong.
NOTE: This is written in a personal capacity and reflects the view of the author. It does not necessarily reflect the view of LWM Consultants. The post has been checked and approved to ensure that it is both accurate and not misleading. However, this is a blog and the reader should accept that by its very nature many of the points are subjective and opinions of the author. This is not a recommendation to buy any product or service including any share or fund mentioned. Individuals wishing to buy any product or service as a result of this blog must seek advice or carry out their own research before making any decision, the author will not be held liable for decisions made as a result of this blog (particularly where no advice has been sought). Investors should also note that past performance is not a guide to future performance and investments can fall as well as rise.