Who Knew? Economics Is Simple Math

I was on the road last week and between meetings I spent more time than usual watching CNBC. I no longer wonder why their ratings are down. They have a lot of hours to fill obviously and right now they are concentrating, seemingly exclusively, on the fiscal cliff negotiations. Last Tuesday, they interviewed a stock broker from Charlotte, NC who is ranked as one of the Top 100 brokers by Barron’s. After watching the interview I have no doubt that he is a top broker because he isn’t letting this fiscal cliff thing stop him from scaring the pants off his clients and getting them to do something. His take on the fiscal cliff was that with growth at 2% and the fiscal cliff equal to 4% of GDP that going over the cliff would produce a recession. +2% minus 4% equals -2%. Who knew economics was so simple? All you need to do is master grade school math and you too can be a Top 100 broker.

Wall Street and CNBC have a vested interest in scaring you half to death over the fiscal cliff. For Wall Street, the cliff represents a reason to call you and get you to do something which is how they make their money in case you’ve forgotten. When asked what he was recommending to clients, the broker said sell stocks and buy municipal bonds. Again, who knew this investing thing was so simple? Cliff bad for stocks. Cliff good for munis. Cliff good for broker. Clients? Who cares? Just keep that money moving.

The only thing I know for sure about the negotiations surrounding the budget and tax policy is that politicians are economically ignorant or liars or both and my bet would be on the last. President Obama and the Democrats have spent a decade talking about Bush’s “tax cuts for the rich” but are now desperate to extend those tax rates for everyone under $250,000 of income. If the Bush tax cuts were for the rich why are they so concerned about keeping them for most people? The answer can be found in a report from the Joint Committee on Taxation which reveals that reverting to the pre-Bush rates would extract $2.7 trillion from the bottom 98% of taxpayers but only $849 billion from the top 2%. Sounds to me like the Bush tax changes benefitted more than just rich folks. Maybe the Democrats aren’t so economically ignorant after all. Raising taxes by $2.7 trillion would certainly make a recession more likely. $849 billion may or may not do the trick but they are obviously willing to make the bet that it won’t so they can claim that they’ve punished “the rich” for having the gall to get that way.

Republicans, on the other hand, tell us that raising tax rates on the top 2% will cause a recession but that limiting their deductions won’t. Are higher taxes bad or are they not? For people who have to write the check to the IRS it makes little difference – at least at these levels of taxation – whether the bigger check is a result of higher rates or fewer deductions. You cannot convince me that the minor change in incentives produced by a small change in rates is the difference between recession or not. Republicans are holding the line on tax rates so they can claim they didn’t raise taxes even if they agree to do so.

Seemingly lost on both parties and anyone else predicting the future course of the economy due to the fiscal cliff is that the fiscal cliff is not a secret. Individuals and companies are taking actions ahead of the cliff and the economic consequences of those actions are already exerting an effect on the economy. Individuals who were considering selling their business have taken action to get the deal closed before the end of the year so they can avoid a higher capital gains tax bill. Companies are issuing special dividends and accelerating payouts before the dividend tax goes up. What are the effects on the economy from the actions taken in advance of the cliff? Anyone who tells you they can calculate that is either deluded or a con man or an economist. You shouldn’t base your investment decisions on the proclamations of any of them.

Not only are actions being taken now to avoid the consequences of the fiscal cliff, but the election itself altered economic behavior even before this latest concentration on the budget. Companies have reported delaying capital investments due to the uncertainty surrounding the election and the potential changes to the tax code. It might be that the mere anticipation of the tax changes has already reduced growth and that going over the cliff – or getting any kind of deal – has no immediate impact on the economy. That doesn’t mean we won’t have a recession – we most certainly will have another one at some point – but if we do the seeds were sown over a year ago when the cliff was negotiated.

How we solve our fiscal problems will matter in the long run but this short term focus on the fiscal cliff is just a distraction. The economy is a lot more complicated than our broker friend in Charlotte imagines and making investment decisions based on CNBC’s coverage of the latest press conference by Boehner or Obama or any other lying politician is, to put it bluntly, nuts. The economic data right now is still mixed with some indicators soft and others not. Maybe more important is what I observed on this recent road trip. Clients and business owners all told me that things are improving. My hotel in Asheville was undergoing significant renovations. My hotel in Augusta, GA was sold out and the parking lots of the others near it were full. Restaurants were packed in both places even on weeknights. Obviously, the economic situation can change rapidly so maybe this won’t last, but for now, the economy appears to be improving and most people just want the politicians and Wall Street to shut up about the fiscal cliff. I couldn’t agree more.

For information on Alhambra Investment Partners’ money management services and global portfolio approach to capital preservation, Joe Calhoun can be reached at: jyc3@alhambrapartners.com or   786-249-3773.

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