The Federal Debt Ceiling: What Is It and Why Should You Care?

Do you remember the good ol’ days?

Yes, we’re talking about the four-year period between 1998 and 2001 when the U.S. government pocketed a budget surplus of $559 billion, according to the Congressional Budget Office. By contrast, in the four years between 2007 and 2010, our government racked up a budget deficit of $3.3 trillion. That’s no misprint – it’s trillions of dollars!

The multi-trillion dollar deficits we’ve incurred in the last few years have maxed out the government’s credit limit.

Just like you and I have a limit on our credit cards, the government, by law, has a maximum amount it can borrow. This maximum amount it can borrow is called the debt ceiling.

The U.S. is one of the few countries where the government imposes a debt ceiling. As a result, if we continue having annual budget deficits, then every few years, Congress has to authorize an increase in the debt ceiling so the government can pay its ongoing bills. As you can imagine, this is not a vote Congress likes to make.

Currently, the government says we’ll hit our debt ceiling on August 2. If Congress does not act by then to raise it, some of the country’s bills may go unpaid, according to The New York Times.

If the government doesn’t pay its bills on time, this would be considered a “default.” And, just like humans, if the government stiffs its creditors, it will face consequences. Those consequences could include a reduction in the country’s credit rating and chaos in the financial markets.

This year, the vote to raise the debt ceiling became especially contentious partly because of the Tea Party’s influence. Some Tea Party politicians and others are trying to rein in government spending and are using the debt ceiling issue as a way to make their stand, according to The New York Times.

As the debt ceiling drama plays out, there’s only one way to ensure we don’t have to worry about this issue again – start running budget surpluses and then return the excess tax money to the public! 

No matter how the debt ceiling issue gets resolved, we’ll continue to monitor the situation and take action that we deem appropriate for our clients.

As always, if you have any questions, please let us know. Thank you very much for your trust and confidence in us.    

Sources:

http://www.cbo.gov/ftpdocs/120xx/doc12039/HistoricalTables%5B1%5D.pdf

http://topics.nytimes.com/topics/reference/timestopics/subjects/n/national_debt_us/index.html

Weekly Commentary July 26, 2011

The Markets

How did our federal budget deficit become so large that we find ourselves in this political quagmire over raising the debt ceiling?

In testimony before Congress last month, Congressional Budget Office Director Douglas Elmendorf laid out a few key points that we should all keep in mind:

·         In recent years, the federal government has been recording budget deficits that are the largest as a share of the economy since 1945.

·         At the end of 2008, federal debt equaled 40 percent of the nation’s annual economic output (a little above the 40-year average of 37 percent).

·         By the end of this year, CBO projects the federal debt will reach roughly 70 percent of gross domestic product (GDP) -- the highest percentage since shortly after World War II.

·         Looking forward, the CBO projects the federal debt will exceed its historical peak of 109 percent of GDP by 2023 and would approach 190 percent in 2035, based on its most realistic estimate.

·         The sharp rise in debt stems partly from lower tax revenues and higher federal spending related to the recent severe recession. However, the growing debt also reflects an imbalance between spending and revenues that predated the recession.

Elmendorf went on to say, “The budget outlook, for both the coming decade and beyond, is daunting.”

Other factors that play into our growing budget deficit include the increase in entitlement benefits related to the retirement of the baby-boom generation and a likely increase in per capita spending for health care as our population ages.

Without boring you with more numbers, any way you slice it, our country has to get a handle on its budget. We can do that by cutting spending, raising revenue (that’s code for raising taxes), or a combination of both.

Democrats and Republicans are arguing over the right split between cutting spending and raising revenue. The bottom line is, they better get something done very soon or we will all pay a very heavy price for their failure!

SPECIAL REPORT ON CHINA

Before China, there was Japan.

From the 1960s to the 1980s, Japan was on a roll. They had one of the highest economic growth rates in the world, according to PBS. Their manufacturing prowess grew to be the envy of the world. Their stock market soared 373 percent between 1980 and its peak in 1989, according to Knowledge@Emory. And, like China today, there were predictions that Japan would overtake the United States as the largest economy in the world.

Oh, but times change.

Japan’s economic miracle came crashing down in the 1990s along with its stock market. By the end of 2010, the Japanese stock market, as measured by the Nikkei 225 index, was down an astounding 73 percent from its 21-year old 1989 high, according to data from Yahoo! Finance.

As happened in Japan, extrapolating past performance could be hazardous to your wealth. Will China suffer a similar fate? If it does, what will that do to the financial markets?

MANAGING THE ECONOMY

China has deftly managed its economy over the past three decades to produce spectacular growth and improved living standards for its people. In fact, economic growth has contributed to more than 500 million Chinese people rising out of poverty since 1981, according to The World Bank. But, growth has its price.

Strong economic growth can lead to problems such as inflation, social and economic inequality, and a growing pile of foreign exchange reserves.

Inflation

Inflation is a major threat to China’s future success because if it gets out of control, the population may revolt. In June, inflation rose by 6.4 percent from a year earlier, the highest rate in three years. Worse yet, food prices rose 14.4 percent while pork prices, a Chinese staple, rose 57 percent in June from a year earlier, according to The New York Times.

Rising food prices is particularly difficult for China to stomach (pardon the pun) because the average Chinese household spends about a third of its disposable income on basic food, according to the Financial Times.    

If you want to know why inflation is a threat, go back to 1989. The Financial Times said, “Inflation of nearly 20 percent is considered a key contributing factor to the 1989 student protests that culminated in the bloody military crackdown in and around Beijing’s Tiananmen Square.”

Social and Economic Inequality

While China’s economy has grown more than 90-fold in the past 30 years, the gains have left a widening gap between the “Haves” and “Have-Nots.” Chinese Premier Wen Jiabao said back in February that rising inequality is threatening social stability, according to a Bloomberg article.

Can you imagine what would happen if even a small percentage of China’s 1.3 billion people turned against the government?

Well, unrest has been on the rise in recent years. As Bloomberg reported in citing data from Sun Liping, a professor of sociology at Beijing’s Tsinghua University, “‘Mass incidents,’ everything from strikes to riots and demonstrations, doubled from 2006, rising to at least 180,000 cases in 2010.”

So, how do you keep 1.3 billion people “in check?” According to Nicholas Bequelin, a China researcher for Human Rights Watch in Hong Kong, China’s been doing it “through a combination of economic growth, social reforms, and political repression.” Time will tell how long that lasts.

Foreign Exchange Reserves

At $3.2 trillion, China has -- by far -- the largest foreign exchange reserves in the world, according to The Wall Street Journal.

These trillions were built over the years through China’s trade surplus, foreign direct investment, and capital inflows betting on yuan appreciation (The yuan is China’s currency.) On the surface, large foreign exchange reserves sound like a good thing, and in some ways it is. The downside is that it exacerbates inflationary pressure, according to Bloomberg.

In an ironic twist, the U.S. has been a beneficiary of this massive reserves buildup. China had to park their cash somewhere, so, where did they turn? To the U.S. treasury market! At the end of May, China was the largest foreign holder of U.S. Treasuries with more than $1.1 trillion filling their balance sheet, according to Bloomberg.

Viewed another way, China has been a big reason why the U.S. has been able to run up trillion dollar budget deficits while keeping interest rates low -- we have China as a willing buyer of our paper.

With China needing a large liquid market to park its reserves and the U.S. needing a big buyer of its paper, these countries have the ultimate “too big to fail” global relationship, said Andy Rothman, an analyst in Shanghai for the investment bank CLSA as quoted in The New York Times.

Conclusion

China is so large and growing so fast, that it will impact the world in major ways for the foreseeable future. Its success or failure, its twists and turns will reverberate throughout the financial markets and affect everything from the level of interest rates to the price of soybeans to the volatility of the S&P 500 index.

Will it stumble at some point? Probably. Yet, no matter what happens, we will continue doing our research. We will continue monitoring your investments. We will continue doing what is in your best interests.

We truly live in a globally interconnected world that is getting smaller and smaller by the day. One thing that does not get smaller is our commitment to you.

Weekly Focus – Think About It

"When it is obvious that the goals cannot be reached, don't adjust the goals, adjust the action steps.” --Confucius, Chinese Philosopher

Weekly Commentary July 18, 2011

The Markets

Will they or won’t they?

Republicans and Democrats are squabbling over raising the federal debt ceiling and jeopardizing a projected August 2 “drop-dead” date for avoiding a default on part of our outstanding debt obligations. Both parties agree that default has to be avoided, but, so far, they’ve been unable to meet in the middle on an agreement. Meanwhile, the economy suffers.

Nobody knows for sure what would happen if our politicians cannot reach an agreement by
August 2, but former Treasury Secretary Larry Summers took a stab at it on CNN last week. As reported by Bloomberg, Summers said a U.S. debt default would cause panic throughout the financial system and long-term uncertainty. He went even further and said a U.S. default would make, “Lehman Brothers look like a very small event.” You may recall that the bankruptcy of Lehman Brothers in September 2008 helped trigger a collapse of the credit markets and contributed to a 28% decline in the S&P 500 index over the next 30 days, according to Yahoo! News.

There’s no doubt that politicians on both sides of the aisle know they are playing with fire right now. That’s why very few people believe the U.S. will actually default. Instead, we may see a last-minute deal that raises the debt ceiling and sets us up for another bruising battle down the road.

Ultimately, tough decisions have to be made. Our country is deeply in debt and there are no easy ways to solve it. Whether it gets resolved now or later remains to be seen.

SPECIAL REPORT ON CHINA

“If you build it, they will come.”

That seems to be an appropriate description of China’s economic growth model. Just one look at Shanghai’s waterfront or train station is enough to leave visitors believing China’s infrastructure can rival anything in the world.

Here’s a June 2011 picture of downtown Shanghai looking across the Huangpu River to the ultra-modern skyscrapers on the other side. That building with the rectangular hole at the top is one of the world’s tallest buildings.

Used with permission

Just 21 years ago, none of the skyscrapers pictured above existed, according to The Atlantic.

FIXED INVESTMENT VERSUS CONSUMPTION SPENDING

A significant amount of China’s growth over the past 20 years has come from what’s called “fixed investment” as opposed to consumption spending. Fixed investment includes tangible things like roads, bridges, trains, buildings, and machinery and accounted for 46% of China’s GDP in 2010, according to the Financial Times. The June 30 launch of the Beijing to Shanghai high-speed train is a good example of fixed investment. It cost $33 billion to build, reaches a top speed of about 200 mph, and connects the two major cities in less than five hours, according to The Vancouver Sun.

Fixed investment is good from the standpoint that it equips a country with the tools and resources needed to grow and be productive. However, too much fixed investment can lead to overcapacity and strained budgets.

Rather than continuing to rely on building and infrastructure for its growth, the Chinese government has developed a plan to rebalance its economy from investment and manufacturing towards consumer consumption and services, according to the Financial Times. Ironically, this would put China more in line with the U.S., where consumer spending accounts for about 70% of demand in our economy, according to The Wall Street Journal. In China, the comparable private consumption number is 34%, according to the Financial Times.

One of the knocks on China is that the growth in fixed investment has risen faster than GDP and this could cause problems with too much capacity and too much debt to fund those investments. Should China falter in its effort to rebalance its economy, it could lead to domestic problems that ripple out to the rest of the world.

There’s an old saying that when the U.S. sneezes, the rest of the world catches a cold. Given China’s strong growth and massive size, we should be concerned about China sneezing, too. How they manage the rebalancing of their economy over the next few years bears close attention.

Weekly Focus – Think About It

“Nature does not hurry, yet everything is accomplished.” --Lao Tzu, Chinese Taoist Philosopher

Weekly Commentary July 11, 2011

The Markets

“This is a big bucket of very cold water.”

That was how Ian Shepherdson, chief U.S. economist at High Frequency Economics, described last week’s ugly U.S. employment report.

We know that one month does not make a trend. But, two months in a row, now that starts to raise an eyebrow. Last week’s employment report was stunningly weak, well below market expectations and the second month in a row that employment numbers were distressingly low, according to The Wall Street Journal. It’s hard to have sustained economic growth when employment growth is in the doldrums.

To put the employment situation in perspective, private payrolls, which account for about 70% of the work force, are still 6.7 million below where they were in late 2007 when the recession began, according to The Wall Street Journal. That hurts.

Paradoxically, even though employment growth has been decidedly weak, the U.S. stock market has performed remarkably well. According to a July 9 Wall Street Journal article, “Factoring in dividends, the Dow on Thursday (of last week) was only 0.1% below its all-time high, while the S&P 500 was off just 6% from its own highest level ever, according to Morningstar.” On top of that, the Dow Jones Transportation Average hit an all-time high last week, according to Reuters.

With unemployment high, economic growth weak, and the budget out of control, how can stocks hang in there? The short answer is corporate earnings. Companies have slashed expenses, cut staff, and become lean, mean earnings machines. CNBC says second quarter earnings are expected to be strong and, for the year, S&P 500 earnings could hit an all-time high.

At the end of the day, corporate earnings are what matters. This week marks the beginning of second quarter earnings reports and we’ll be watching them very carefully for signs of either growth or weakness.

SPECIAL REPORT ON CHINA

Is the “Age of America” about to end? Will China become the world’s largest economy? What does the rise of China mean for investors?

For much of recorded history, China was the world’s largest economy. Even into the early 1800s, it accounted for 30% of the world’s GDP, according to The Economist. But, like many empires before it, China spectacularly flamed out over the next century. By the mid-1970s, the disastrous reign of Mao Zedong was coming to an end and China was near rock bottom.

In 1978, new leader Deng Xiaoping laid out a vision of economic reform that has propelled China to unprecedented growth. Since then, China has been massively reshaping the world order as its growth and demand for resources affects everything from auto production, to corn prices, to funding the U.S. budget deficit. Earlier this year, China overtook Japan as the world’s second largest economy behind the U.S.

Given the importance of China in shaping world events, we thought it would be helpful to review some of the facets of China’s phenomenal rise and what that may mean for our clients like you. Today, in the first of a series, we’ll look at demographics.

DEMOGRAPHICS

Incredibly, China’s GDP has grown at an average annual rate of 9.3% since 1989, according to Trading Economics. Yet, for all its might, there are some glaring holes that might trip it up over the coming years -- with demographics being one of them.

You may be surprised to know that between 2000 and 2010, the U.S. population grew faster than China’s (9.7% in U.S. vs. 5.8% in China, according to Financial Times). For the past 20 years, China’s economic boom has been partly fueled by urbanization -- rural folks moving to the cities in search of higher paying jobs, plus a supposedly endless supply of cheap young workers. Turns out that supply may be coming to an end.

China has had a one-child policy since 1979 and it resulted in the “non-birth” of about 250 million babies, according to Time Magazine. As a result, China’s population is aging rapidly. Today, 12.5% of China’s population is over 60. By 2020, it will hit 20% and by 2030, it will hit 25%, according to The Economist.

Worse yet, the working age population will start to decline in about 2015, according to the United Nations. Fewer workers supporting a growing elderly population is not a recipe for economic growth.

Of course, China could reverse its one child policy and rev up population growth, but that would likely cause other problems such as food shortages or environmental issues.

As the demographic shift causes the labor market to tighten, wages have already started to rise, according to The Economist. That puts pressure on inflation and makes the country less competitive.

While it’s easy to look at China’s growth over the past 30 years and extend it for another 30, changing demographics are one of several hurdles that could put the brakes on growth. Next week, we’ll look at the challenge of moving China’s economy from one led by exports and investments to one led by consumption.

Changes within Cornerstone Wealth Management

We have a couple of exciting announcements we would like to make you aware of here at Cornerstone Wealth Management. To begin with, on July 1st of this year our company name changed from Cornerstone Wealth Management to Triad Financial Strategies. Cornerstone Wealth Management was founded on the following principals:

…traditional values; accessibility, hard work, benevolence, honesty, and commitment. When we manage your money, you get all this and more. Guiding our clients through the process of obtaining financial independence so that they can focus on the most important things in life.

Our goal has always been to create an organization that is able to assist you in all areas of your life. We provide many exceptional services with three main pillars of expertise – Financial Planning, Investment Management and Tax Planning. To emphasize this, we felt that a name change was necessary to help communicate this. We feel that all three of these services are interwoven and should not operate independently. For that reason, the name Triad Financial Strategies was created. In combination with our core foundational principals our continued effort to provide world class service and comprehensive financial services, we know that you will find this change as positive.

At Triad Financial Strategies, we will continue to constantly strive to “raise the bar” on our ability to deliver extraordinary service to our clients. As such, I am very pleased to announce the recent addition of Christine LeVay as an Insurance Specialist to Triad Financial Strategies. She will be greeting you with a welcoming smile when you come into our office, but her primary role will be to bring her extensive knowledge in insurance and fixed income solutions to you. In addition she will be focusing on continuing to work with her existing clients while also assisting me.

Christine comes to us from Bankers Life & Casualty where she specialized in assisting her clients with their life insurance, Medicare supplements, long term care and income needs. During the planning process our clients consistently have needs in this area and Christine will bring additional strength to our team. Christine believes strongly in extraordinary client service and knows that this can only be achieved if our infrastructure runs seamlessly for our clients and consistently focuses on improvement.

In addition to a new company name and team member, thanks to many of you, I was recently voted as a 2011 Five Star Wealth Manager in the April issue of the Seattle Magazine. This honor is very much humbling and appreciated. This recognition provides me with confidence that we are not only meeting our clients’ needs in a way that is satisfying to them, but that puts us in the top 7% of all financial advisors in the Seattle Area. Thank you again for helping me achieve this distinct honor, and also for those of you that have continued to entrust your closest friends and families to us by referring them. We are extremely grateful for these introductions because we love working with our clients and the people that are closest to them.

With all of these exciting things happening within our firm we wanted to have an Open House to give everyone a chance to stop in and say hi to Christine and the rest of the team. We are hosting our Open House on 7/19 from 4-6pm. We will be providing light appetizers as well as red and white wine. Please come join us, we would love to see you.

Finally, with our name change taking effect on July 1st, some of our contact information will change. While our address and phone numbers will remain the same, our website and email addresses will not. Our new website will be www.triad-fs.com and our email addresses will be our first name followed by @triad-fs.com (i.e. Tait@triad-fs.com). We are also enhancing the ways we communicate with you, and would enjoy connecting with you online. Connect with us on Facebook, Twitter, or LinkedIn to receive regular announcements, articles and additional valuable updates. You will find links to our social media sites on our new homepage of our website.

We look forward to continuing to serve all of you now and in the future. Please contact us if we can assist you or anyone else.


Best regards,

Tait Lane, President
Triad Financial Strategies