5 Ugly Truths About Life After the Debt Deal

by Jeff Reeves | August 4, 2011 12:01 am

Yesterday, the Senate approved legislation to raise the $14.3 trillion debt limit and immediately grant an additional $400 billion in government borrowing. Obama signed the bill just hours before the deadline where the Treasury said it would stop paying the bills.

There is no end to the commentary about the package, no shortage of debate about whether the deadline was truly the point where Uncle Sam’s change purse was empty and no end to the speculation over which party “won.”

What I’d like to focus on is life after this debt deal — specifically, five ugly truths about our legislators and our nation’s economy.

U.S. political dysfunction is only beginning

The so-called “super committee” that was part of the debt deal is a scary thing. The general idea is a 12-member debt reduction commission, and while the berths were unfilled as of this column deadline, I have no doubt of the kind of people who will get a seat: the fattest fat cats in Washington.

Say what you want about the inefficiencies of Congress, but at least there were a few brave souls willing to defy party leadership and vote their conscience — and even those I disagreed with, I admired for swimming against the tide. Now we will see Washington at its worst, with 12 partisan hacks who are more interested in power and electioneering than a true solution to America’s debt crisis.

Some shrug and say this is no different than military base realignment, where a committee crafts an ironclad plan for an up or down vote rather than allow cumbersome changes by legislators protecting disparate interests. That’s horse manure. You can understand why a U.S. representative who has a base in his district would have difficulty thinking objectively about the whole package, but America’s debt affects us all equally. We all have equal skin in this game — but somehow Congress has decided a dozen Washington insiders know best.

Forget about a seasonal boosting to stocks this fall

The market has plenty of cleverly named schemes relating to the seasonal strength of the market around the end and beginning of the year. There’s “sell in May and go away” until October, the Santa Claus rally and the January Effect. None of these phenomena are 100% certainties, but all carry at least superstitious weight.

Unfortunately, the recent debt legislation places a big lump of coal in investors’ stockings this winter by the aforementioned super committee. This group, charged with the daunting task of finding $1.5 trillion in debt reduction over the next decade, has perhaps the most Grinch-like schedule possible. The deadline for their proposal? Thanksgiving. The deadline for Congress to give an up or down vote on the package? Christmas. So much for happy headlines around the holidays.

The political rancor that is sure to arise in Washington will also certainly shroud Wall Street in uncertainty and doubt. And, as we saw the last few weeks, that’s not good for the market. In short, kiss the seasonal strength of the market goodbye thanks to the toxic politics that are sure to hang over the holidays.

QE3, here we come

Fundamentally, America needs Congress to suck it up and take decisive action on the hard issues. Instead we get intransigence and infighting. So it’s ironic that many think America needs the Fed to just get out of the way — even as the central bank insists on doing more. While many folks doubt the efficacy or fiscal responsibility of “quantitative easing” to spur lending and stimulate the economy, it seems likely the Fed is going to embark on yet a third go-around of this unconventional and sometimes unpopular monetary policy.

Chairman Ben Bernanke has tried to act coy about QE3, saying he would only get involved if the fragile recovery seems like it may fall apart altogether. Well, an ugly alphabet soup of reports hit the market this week — from the ISM slump to disappointing GDP numbers to what assuredly will be a poor ADP payroll report Friday — should convince Ben things are dire. Perhaps the only reason not to embark on QE3 is the threat of inflationary pressure, but oddly enough Bernanke still claims inflation is moderate. So don’t bank on that deterring the Federal Reserve.

U.S. credit rating should be downgraded

The idea of a simple either/or equation for the debt ceiling debate — that we either raise the borrowing limit and everything is OK or we default and face a disastrous credit downgrade — has long been an oversimplification. The persistence of partisan bickering, brinksmanship and flat-out misinformation on both sides of the aisle is proof that the crisis in federal spending confidence surrounding is far from over.

My InvestorPlace.com colleague Dan Weiner, one of the top Vanguard mutual fund analysts on Wall Street, recently wrote rather buntly, “Frankly, if the ratings agencies don’t downgrade U.S. debt, it will be just another shocking example of their inability to really understand what’s happening in the world.” I couldn’t agree more. What our politicians need to realize is that the rest of the world is taking this debt crisis seriously, and it’s about time they did, too. If we have to suffer a credit downgrade to achieve that, so be it.

We are no better than the eurozone or Japan

The ugliest truth of all is that America is no longer the economic superpower it once was. Many folks have clung to rather naïve notions that 2011 was going to be better than 2010. Stocks were supposed to find another leg up, housing might rebound, unemployment could steadily decline, GDP growth would continue to heat up. In short, we expected that America would do what it does best — pull itself up by its bootstraps and prove to the world who’s boss.

Well, it’s time to realize that the world has changed. The debt debate in the U.S. is not unlike the austerity fights in Europe — only instead of Greece fighting Germany, it’s Democrats fighting Republicans. And just like Japan watched its economy struggle as red-hot growth propelled China past it in a big red blur, America is watching emerging markets continue to thrive as its growth flatlines.

It’s a harsh reality, but the sooner we accept this, the better. It’s the only way to think rationally about what’s best for our economy and our federal budget in the long term.

Jeff Reeves is the editor of InvestorPlace.com. Follow him on Twitter via @JeffReevesIP and become a fan of InvestorPlace on Facebook.

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