A warning shot across our bow

Last Monday’s surprise announcement that the outlook for U.S. debt has been downgraded reverberated around the world. Global markets shuddered. Investors rubbed their eyes as they reread the announcement and then hit the “sell” button. Markets declined by 1 to 2 percent. Yet, by the end of the week, stocks and bonds recovered. Was this some kind of false alarm? First the facts: The Standard & Poor’s Rating Services Inc.(S&P) has reduced the outlook for U.S. debt from “stable” to “negative.” It did not change its AAA rating for U.S. federal debt nor does it plan to do so anytime in the near future. But it is potentially the first step in an actual ratings downgrade. The White House had been given advance warning the Friday before. Officials tried to forestall the credit agency’s actions, but S&P is convinced that our high debt and deficit levels are raising the possibility that the U.S. fiscal situation could become “meaningfully weaker” if the government fails to improve the country’s financial health.A barrage of spin doctors, led by Treasury Secretary Timothy Geithner, was launched on the nation’s airwaves this week in an effort to assure one and all that there is no cause for alarm. It reminded me of that scene in “The Wizard of Oz” where Toto pulls the curtain away from the Wizard revealing his fire-breathing, smoke-making, image projection machine.“Pay no attention to that man behind the curtain,” the Wizard bellows through his loud speaker system. But like Dorothy, we Americans should ignore the Wizard’s advice whether in Oz, or in this case, Washington.The change in the ratings outlook, like a warning shot across the nation’s bow, says to me that unless we get our house in order, and do so quickly, there will be hell to pay.S&P recognizes that all the grandstanding going on right now between the political parties is just that. They have no intention of doing anything about the deficit until after the next election. Both sides are simply jockeying for position. They are using the deficit to put their presidential candidate and party in the best position to capture the election, which is still two years away.S&P’s base case assumes $4 to $5 trillion in deficit reduction would need to occur over the next 10 to 12 years, but it also insists that there needs to be a concrete plan in place for deficit cutting that is actually implemented by 2013. That implies a spending decline of at least 20 percent of U.S. GDP and an agreement prior to the next presidential election.What’s at stake here is another Black Swan event, in my opinion. If the politicians flub this one and our credit rating is cut, I suspect the greenback will be worth about half of its value today. Interest rates across the board in the United States will skyrocket. That will pretty much gut any hopes of a continued economic recovery and the unemployment rate … well, you get the picture.You might wonder, therefore, why the politicians are stalling since they know the consequences as well as you and I do. Taxes, a cut in spending, this year’s budget, the debt ceiling — everything appears to be a political football. Politicians blithely fiddle while Rome burns because they all know the truth behind the nation’s books.Historically, politicians and their parties have very little to do with balancing the nation’s budget. The most important single variable, when it comes to reducing the deficit, balancing the budget or actually enjoying a surplus, is economic growth. The stronger and longer the period of economic growth, the faster the deficit is reduced. The problem in this recovery is that due to its nature, the U.S. recovery has been anemic and therefore revenues (taxes) aren’t coming in fast enough to reduce the deficit as it has in prior economic cycles.This time around, a combination of growth and spending cuts are called for, but politicians on both sides of the aisle are notorious for kicking that particular can down the corridor. The S&P is warning them that “the can stops here.” Who is Bill Schmick?Beginning this week, The Lakeville Journal newspapers will begin regularly running a new column, The Independent Investor, by Bill Schmick.After three decades on Wall Street, Schmick knows the global financial markets better than most. As a portfolio manager for Berkshire Money Management in Pittsfield, Mass., he manages the life savings of hundreds of Tri-state residents through the ups and downs of the markets. The only thing he loves more than finance and investment is writing about them.Each week Schmick brings his experience to bear on what is really going on behind the world’s business headlines. He addresses topics that range from the future directions of the markets to trends in retirement, economics and local topics that will connect you to your money and help you save toward retirement.“There’s too much misinformation, needless jargon and just plain lies thrown around in this business,” says Schmick, who lives in Hillsdale, N.Y., with his wife, Barbara, and their Labrador retriever, Titus.“I try to cut through the BS for my clients and my readers because there aren’t a lot of writers doing that. Part of the problem is their lack of hands-on experience. How many journalists have actually worked on Wall Street for 30 years?”Schmick, a former Marine who served two tours in Vietnam, is a Fulbright Fellow who holds an MBA from New York University and a certificate in financial planning from Kaplan University. Schmick is registered as an investment advisor representative with Berkshire Money Management. His forecasts and opinions are purely his own. None of the information presented here should be construed as an endorsement of BMM or a solicitation to become a client of BMM. Direct inquires to Schmick to 888-232-6072 or e-mail him at Bill@afewdollarsmore.com.