I’ve been watching the new reality show “DC Punk’d,” where Congress and the White House fight over which can play the stupidest practical joke on the U.S. economy.
It might be funny if these idiotic games did not affect your well-being and mine.
The Aug. 2 deadline for raising the debt ceiling is now only one week away. My guess is Congress will find a last-minute solution to prevent a real catastrophe, but some damage has already been done.
Countries that hold our debt are not amused by the political wrangling. How would you feel if you loaned money to a rich cousin who bought a beach house and a Ferrari and then told you he did not want to pay you back? The Chinese, Japanese, Saudis and others feel the same way. The next time we ask them to finance our spending, they may exact tougher terms.
You can bet that any compromise will involve significant spending cuts. While no one has yet detailed the specifics, cutting $1 trillion to $2 trillion will put further pressure on the economy. Meanwhile, QE2 is now finished, and it appears the government has neither the appetite nor the resources to finance another stimulus. This means that unemployment could increase and economic growth could slow.
With more spending cuts and potential revenue increases looming as both parties commit to deficit reduction, real recovery could be a long way off. We will likely be looking at three to four years of 9%-10% unemployment and 1%-3% growth.
Low- to middle-income consumers could be especially hurt. The Republicans are blocking tax increases or loophole-plugging that could hurt the rich, and many of the cuts will come from programs that now benefit low- and middle-income consumers. This means that companies that cater to these consumers could be hurt.
Corporate profits also could feel the pain. Coming out of the recession, corporations took an ax to costs and thus were able to report strong profits. But for many, there is little more room to cut. Without economic growth, profits could come in lower than expected.
There is also the serious issue of whether this debt-ceiling compromise is a short-term fix or a longer-term solution.
Corporations and investors hate uncertainty. If the compromise is only a short-term stopgap, corporations may be nervous about investing in new facilities or increasing employment until they know the rules of the game. This could put further pressure on the U.S. economy.
So what should you do as an investor? First, keep some money on the sidelines. There is still a risk that things could go wrong, and the downside if they do could be substantial.
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