The Second Act
This is an archived article written November 4, 2004 [edits added November 2005]
The Second Act: Things To Watch For In George W. Bush’s Second Term
Now that the American electorate has spoken it is time to examine what another Bush Presidency could mean to your pocketbook. As many of you know, I am unabashedly moderate. Such a stance puts me on par with a majority of Americans, but not particularly relevant in partisan politics. If you find any of this article a little harsh, don’t worry, I was tough on the other guy too. I wrote rough drafts of this article and one entitled “A New Face” (had John Kerry won the Presidency) a few weeks ago.
With Republicans controlling the Presidency, Congress and increasingly the Judiciary, President Bush’s second Presidency will bring partisan power to the federal government not seen in over a generation. It will be interesting to watch whether or not Congress and President Bush continue to cater to the far right factions of the Republican Party or if more moderate stances will predominate. During election cycles, the extremes of each party get far more attention than their real numerical or common sense value. However, once those votes aren’t needed to secure a government position, those extremists are usually left on the outside looking in. For President Bush’s part, he appears ready to take a step towards the middle. Congress and the Vice President may not be so willing.
What are the financial implications of this lock on power? Obviously, much will depend on what limits the President is willing to impose on some conservative sub-groups within the Congress. Regardless of what does happen over the rest of President Bush’s term and a few years after, it is clear that the credit or blame will fall squarely at the feet of the Republicans.
To this point, as my clients know, I have given a fairly blanket pass to the Republicans and President Bush regarding the nation’s economic and financial difficulties of the past few years. I think a reasonable doubt exists that recent Republican policy has adversely affected the economy or finances of the country. As I’ve discussed with many clients, much of the financial and economic negatives of the past four years were likely largely cyclical and due to the changing nature of the global economy. Further, our necessary response to terrorism has clearly used resources that could have been allocated elsewhere. Many of our problems are also due to the ridiculously low private savings rate in this nation.
Regardless, we can not deny some very serious negative occurrences of the past four years:
- Net job losses
- Lower median incomes
- Energy price increases
- Hard asset/materials price increases
- Increasing environmental damage costs
- Healthcare cost increases
- Reduced access to affordable education
- Record Trade Deficits
- An expanding National Debt
- A bear market in U.S. Stocks
- A weaker dollar
Further, the housing market appears to be developing a bubble that may become dangerous. Credit is extremely easy for reasons I do not fully understand. The FBI has identified massive fraud in mortgage lending as mortgage lenders have been popping up in every other strip mall I see. In a recent conversation with a real estate broker friend he made it clear to me that he believes that there is no way, short of a huge economic expansion or population boom that housing prices can continue to scream upward as they are. It appears that action to limit a potential real estate collapse is necessary. [paragraph added November 2005]
Beyond noting the problems I see, I am not going to discuss specific policies other than to say that there don’t appear to be many new initiatives necessary for the government to create. Funding existing programs properly and writing legislation to be inclusive rather than exclusive, along with effective regulation seems to be the only necessary changes apparent to me. I am basically against new bureaucracies when fixing old ones will do. Today, there is clearly some fixing that needs to be made as significant financial deregulation has created holes in our capitalist quilt. Finally, just a note that politicians can not make, it is time that Americans stop asking for new programs and insist that the existing ones work or be eliminated.
Next, let’s discuss the developing debt and currency crisis that will affect middle Americans more than any other issue.
Debts, Deficits, Currency Devaluation, Growth Rates & Protectionism:
Though the United States currency carries a lot of good will, a further decline in the value of our currency versus others is not unlikely. In fact, due to our expanding national debt and trade deficits, further devaluation is almost a certainty. If the devaluation is sudden and hard, it will trigger a series of events, likely culminating in protectionism and the global economy plunging into a recession that we would fully share in.
What would it take to further devalue the dollar? The foremost cause would be further erosion of the national balance sheet. If we keep taking on debt in the amounts that we have been, our ability to pay back what we owe would eventually come into question.
The Republican method of improving the national balance sheet is to cut taxes in order to stimulate growth. Continued deficit spending and tax cuts are a highly risky set of policies if more fully enacted. For such policies to be successful, our growth rates would have to surge. In theory, such a policy can work under ideal conditions. The Republicans are currently married to this path of action. Unfortunately the conditions for success have rarely existed in the history of man, and I don’t believe exist now.
Compounding our financial challenge is that a major miscalculation was made with regard to Iraq financially. Because the Iraqi insurgency has remained strong, and the Iraqi infrastructure and oil fields are in much worse disrepair than anticipated, the true cost of the war is going to be about what we spend on it; not less some recovered amount. The cost of the Iraq war will have a much larger impact on our economy than originally anticipated. The previous round of tax cuts and spending was clearly based on a more favorable financial outcome with regards to Iraq.
There are significant risks from the neo-conservative factions of the Republican Party that implicitly support policies that lead to currency devaluation. There are also some who argue that a devalued dollar is beneficial in that it makes American exports more competitive. This is true, a weaker dollar will help a handful of corporations. However, a weaker dollar will also increase the cost of imported goods– most notably energy. A weak dollar acts as a deflator of income. Can you think of a time in your life when you have been happier with less income? I thought not.
Further, a deeply devalued dollar, especially in an age of increasing global markets, makes investment in America a less appealing opportunity for foreigners. The risk of capital flight, which would likely lead to an American recession, and constrict debt and equity markets, is significant. This event would derail the increases in productivity that are requisite to growing ourselves out of this quandary.
Solving our deficit issues require that we sell more to foreigners as they become more consumer oriented and save more of our money instead of spending it. From a sales standpoint, we had better play nice with our neighbors. Manipulating capital markets– which is antithesis to what many neo-conservatives espouse– is a dangerous game. As a nation we need to produce more and spend less. Clearly, working harder and tightening our belts is not what people want to hear. I suppose that’s why politicians who talk about that usually lose elections. Unfortunately, if we don’t take the path of patience and prudence, middle Americans will go through a period of more profound suffering.
To offset our own financial shortcomings, we will have to rely on much of the rest of the world to support us as we dig out from this problem. Frankly, I do not believe that enough foreign governments will stand for this– they have their own problems. Implicitly letting the world know that we are going to deflate the dollar, which is what appears to be happening, runs the risk of damaging a fragile, and necessary, globalism. Most likely, the politicians that support policies that devalue the dollar, would also support protectionist measures. Protectionism sells at the ballot box, but does not work on any large scale. What we must do instead is reduce consumption, trim our own debts and increase our savings rate.
What Can You Do
It is my belief that you have to plan for the possibility that the risks above both materialize into problems and don’t materialize into problems. A tough task, but it can mostly be done. Your asset allocation strategy will be the key. Being over-weighted in the asset classes that historically benefit and underweighted in the asset classes that historically get hurt under the current conditions will be very important to your risk/return ratio. If a rising tide occurs and lifts all ships, fine, you win that way too.
One thing you can do that might make a lot of sense is sell your house if you are not planning to live in your house another fifteen to twenty and down-size or rent for a few years. I have been criticized for this advice every time I bring it up, but real estate appears over-valued. If real estate collapses, it will be a hard fall that takes a very long time to climb back from. If you choose to wait and see, remember to significantly reduce your asking price immediately upon deciding to sell if you do not get a buyer quickly at your preferred price. Falling behind a declining price curve in any asset, especially illiquid real estate is a recipe for losses. [paragraph added November 2005]
Also, get into a systematic investment plan for a Roth IRA if you aren’t already doing so. This form of dollar cost averaging will help you invest without worry of getting in at the wrong time*. If you are not closely managing (or having managed) you retirement plan at work, do so! Under the likelihood that you don’t have access to several of the investment classes I mentioned above within your plan, check into an in-service non-hardship withdrawal from your plan. Many plans will allow you to transfer money tax-free to an IRA that you will have greater investment flexibility with. Remember, the “ownership society” will only work for those who invest in it and manage what they have invested.
At a more personal level, and I don’t say this completely in jest, insulate your house because energy prices are heading higher. Also, learn additional higher value work skills. Outsourcing of jobs will continue to occur as the economy is pushed towards higher skill levels. Manufacturing in America will be defined by the work that is more highly skilled and requires continuing education. Encourage your kids at every term to strive for more academic success– it will be the key to them not having to move back in more than once.
Finally, to close on a happier note, I do think that regardless of how the short term shakes out, the intermediate and longer terms appear to be looking very bright so long as we don’t allow the basic financial fabric of the nation to be damaged. The United States continues to have a stronger spirit, resources and will than virtually any other nation.
If you have any questions or thoughts, please contact me .
*Dollar Cost Averaging does not ensure a profit or protect against a loss in a declining market.