What is to be done?

One of the market experts we follow is Jim Swanson who is the Chief Investment Strategist for MFS Investments.  He typically provides an interesting and insightful perspective on global events.  We especially enjoyed reading his comments on the recent European elections and have decided to share them with you. 

Posted: 10 May 2012 02:14 PM PDT by Jim Swanson

"The fault, dear Brutus, is not in our stars,
But in ourselves, that we are underlings."
-Julius Caesar by William Shakespeare

The recent elections in Europe have created a new crisis of confidence in the world markets. Last year, fear of contagion raged, as bank failures spread throughout eurozone. This year, we are experiencing a different kind of contagion. Voter backlash has swept two austerity-imposing governments from power and now threatens other eurozone regimes that have tried to impose their harsh brand of fiscal authority in an effort to appease European creditors.

In France, the president has been thrown out. In Greece, newly elected legislators from the left-of-center party are demanding a reversal of what they are calling the "barbarous" austerity measures agreed to by the former government.

With more elections on the way, politicians are now taking a fresh look at the timing of budget cuts that are being implemented with the eurozone in the midst of recession. They seem to have concluded that growth and austerity are incompatible. But, is that really the case, or is it rather a case of who or what is fueling the growth that will enable a country's economy to be lean at the same time that it is prosperous?

Social Security Board of Trustees Report Released

The 2012 annual report on the financial status of the Social Security Trust Fund was recently released by the Social Security Board of Trustees.  Under the current system, the Board’s long-range projections indicate the combined OASDI (Old-Age and Survivors Insurance and Disability Insurance) Trust Funds may be exhausted in 2033.  It’s noteworthy that this projection is 3 years earlier than the Board projected within its 2011 annual report.  It is estimated that only 75% of scheduled benefits will be available for recipients once the Trust Funds are exhausted. 

The report urges legislators to act soon to increase the program’s solvency and provides the following options for the combined Trust Funds to remain healthy for the full 75-year projection period:

1.    Permanently increase the payroll tax by 2.61% (split equally at 1.305% each for employee and employer),

2.    Immediately reduce scheduled benefits by 16.2%,

3.    Create more revenue, or

4.    Some combination of these options.

Our view is that Social Security will certainly remain in place, but lawmakers will be forced to make changes eventually – as have occurred in the past – to create long-term stability.  These changes will most likely impact younger generations and may consist of increasing the Social Security defined full retirement age, reducing benefits for high income wage earners, increasing the taxability of benefits (currently up to 85% of benefits are subject to federal income tax), raising the amount of income subject to the payroll tax ($110,100 currently), increasing the payroll tax, etc.

The full 242 page report can be found here:  www.socialsecurity.gov/OACT/TR/2012/. 

The Fiscal Cliff

It is looming!!!  In his recent congressional testimony, Fed Chairman Bernanke stated, “Under current law, on January 1, 2013, there’s going to be a massive fiscal cliff of large spending cuts and tax increases.”  This is the date when the Bush-era tax cuts, the temporary payroll tax cut and extended unemployment benefits are all due to expire.  To make matters worse - since the Congressional Super-Committee failed to reach consensus last year on reducing government spending we will also see $1.2 trillion of automatic spending cuts begin on the same date.  Combining tax increases with spending cuts could push our economy back into recession.  It is anticipated that economic output would be reduced by 3.5% next year if all these things come to pass.  

We remain hopeful that a more thoughtful approach is taken regarding spending and tax cuts by Congress and the President prior to meeting the fiscal cliff Chairman Bernanke speaks of.  However, the risk of policy errors and continued political dysfunction, particularly in an election year, remains very high.  We will continue to monitor these issues closely as the year progresses.