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Fiscal Cliffs and Economic Woes

U.S. News and World Report Smarter Investor

Post-election questions mean the economic puzzle is still incomplete.

Now that the stress of the election is over, you might find yourself sleeping a little better at night. But even though its conclusion brings a feeling of relief, it does not mean that any of the real challenges this country faces have been solved.

Today, neither party want to be blamed for letting us fall over the fiscal cliff, and there is a lot of goodwill to be generated for the one that can lay claim to solving the problem, or at least kicking the can a little further down the road.

So where does the election leave the average investor? A couple of pieces of the puzzle are beginning to fall into place just by knowing who is in the White House, and that nothing really has changed in the House or the Senate. But it looks like gridlock as usual, except we are roughly 50 days away from going over Niagara Falls in a barrel. There is a pretty good chance we will survive, but there is a chance that we won’t. Either way, that is a thrill ride that most of us would prefer not to take.

Fiscal Cliff
More broadly, there’s our national debt. Keynesian Democrats say that in the wake of a financial crisis, the government has no choice but to increase spending by taking on additional debt until the private sector can rebuild its balance sheet and resume its role in increasing economic activity. The question here is just when the economy will be strong enough that the government can turn off the financial spigot?

Meanwhile, austerity-minded Republicans contend that immediate and corrective measures need to be taken to reduce that debt, and a very close watch on the percentage of debt to GDP is of utmost importance. This argument contends austerity should be instituted now for the people who benefited from the overspending, rather than passing the problems on to future generations.

Both have merit, but one is much more tolerable if you happen to be a politician.

What investors need to be looking for is the point at which politicians say “enough is enough.” The ratio of debt to GDP is getting dangerously close to the tipping point where the economy can no longer support the repayment of its debt, and the interest expense on the debt itself starts to decrease GDP. If that happens, the likelihood of being able to grow our way out of the deficit becomes greatly diminished. The U.S. was able to manage its way out of such a situation after World War II, as did the United Kingdom prior to the Industrial Revolution. I am not saying it’s impossible. I am saying it’s kind of like wanting to go over the falls in a barrel repeatedly. Sooner or later, the odds will catch up to you.

There have been numerous studies on the effects of economies where the level of debt exceeded 90 percent of GDP, and the stories don’t end well. Take a quick look at the headlines from Europe. It should be clear to everyone that the actions that our elected officials have taken in the past few years fall into the first scenario I described above.

Investors need to look at how our politicians are spending or investing our money. Is it for current consumption, meaning the spending simply maintains our current standard of living (this includes entitlements), or is it for investment purposes, meaning something that will generate a future income stream or provide a future benefit, such as infrastructure improvements and other high-return capital projects? How tax money has been and will be spent, and the return (or lack of return) we get is another important piece of the puzzle.

Timothy S. MicKey, CFP®, is a Managing Director and co-founder of Alexandria, VA-based Monument Wealth Management, a full service wealth management firm located in the Washington, DC area. Tim and the rest of the Monument Wealth Management team can be followed on their blog at “Off The Wall”, on Twitter @MonumentWealth, and on their Facebook page. Securities and advisory services offered through LPL Financial, a Registered Investment Advisor. Member FINRA/SIPC.

Securities offered through LPL Financial, Member FINRA/SIPC. Investment advice offered through Monument Advisory Group, LLC, a registered investment advisor. Monument Advisory Group, LLC, and Monument Wealth Management are separate entities from LPL Financial.

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