Last week,
investors took a long look at the crazy quilt of information and events around
the world and decided they didn’t like what they were seeing.
Geopolitical
tensions puckered a lot of seams: Conflict in Ukraine was embroidered with additional
sanctions against Russia, difficulty investigating the downed commercial
airliner in Ukraine, and escalating anti-American rhetoric in Russia. Violence
continued to roil through Middle East and North Africa. In Libya, hostilities
escalated, causing many western countries to withdraw diplomats and leading
Tunisia to close its border with the country.
Financial and
economic issues overseas, including ongoing issues with one of Portugal’s
largest banks, and worries that European companies will be negatively affected
by sanctions against Russia, marred investors’ views, too. In addition, controversy
swirled around Argentinian bonds. In the midst of a legal battle over bond
repayment, the country missed a June interest payment. The ‘credit event’
triggers a payout of about $1 billion for investors who hold insured Argentine
debt.
Positive news in
the U.S. offered some padding. The U.S. economy continued to recover and gross
domestic product increased by 4 percent (annualized) during the second quarter which
was a remarkable improvement after first quarter’s contraction. Reuters reported, “Consumer spending
growth, which accounts for more than two-thirds of U.S. economic activity,
accelerated at a 2.5 percent pace… Despite the pick-up in consumer spending,
Americans saved more in the second quarter… which bodes well for future
spending.”
The Federal
Reserve issued a midweek statement confirming economic recovery was continuing
apace. It caused some investors to throw what one expert called a ‘taper’
tantrum. Barron’s said, “As the Fed's
easy money policies reverse, people are forced to focus more on what they're
paying for investments. If last week is any indication, investors didn't like
what they saw in their portfolios.”
By Friday, U.S.
markets had experienced their worst week in two years. As investors adjust to
the idea of rising interest rates, markets may experience additional volatility.
Just as some science fiction novels
describe parallel universes, the Congressional Budget Office (CBO) report
entitled The 2014 Long-Term Budget
Outlook described alternate realities for the United States, including futures
that will be determined by the decisions of our
policymakers today and in the future.
The
CBO reported, “Between 2009 and 2012, the federal government recorded the
largest budget deficits relative to the size of the economy since 1946, causing
its debt to soar.” A deficit occurs when the government spends more than it
takes in. One consequence of recent deficits is the federal debt (the amount of
money the United States owes its creditors) is now equal to about 74 percent of
the U.S. economy’s gross domestic product (GDP). That’s the highest percent ever
except for a short period around World War II.
If
nothing changes – meaning laws governing taxes and spending remain the same,
and the economy recovers as anticipated – deficits are expected to remain
relatively low from 2015 through 2018. However, after that, the CBO projects government
spending on healthcare programs and interest payments will grow and the federal
debt could be 106 percent of GDP by 2039.
In
an alternate universe, “certain policies that are now in place but are
scheduled to change under current law would be continued, and some provisions
of law that might be difficult to sustain for a long period would be modified.
With those changes to current law, deficits, excluding interest payments, would
be about $2 trillion higher over the next decade than in CBO’s baseline.” In
that scenario, the debt of the United States balloons, swelling to about 180
percent of GDP by 2039.
A
more attractive alternative requires deficit reduction measures. Depending on
the amount of deficit reduction, the federal debt could diminish and be 42 to
75 percent of GDP by 2039. We can only hope the United States isn’t the country
to answer an economic question recently discussed by The Conference Board: How high can debt-to-GDP ratios rise before
crippling a nation?
Weekly Focus – Think About It
“The most
difficult thing is the decision to act, the rest is merely tenacity.”
--Amelia Earhart, American aviation pioneer
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