There have been times in the past when it seemed as if we were in the proverbial calm before the storm. Maybe I can be accused of reaching here, but I think we?re having another one of those times. I?ve heard and seen all of the positive news just like everyone else has ? the record stock market, rising tax revenues, a declining unemployment rate, the rising stock market, the spectacle of the Olympics, and of course, the rising stock market (yes, I?m making a point). Still, I can?t help but get the feeling that world events are starting to get spooky.
Sure, on the surface everything seems fine and there is evidence of improvement. But it?s hard to shake the feeling that events have been unleashed that threaten to change the current economic dynamic into something far less pleasant.
The Double Threat – The FICA Payroll Tax increase + Obamacare
2013 saw the initiation of two major changes in the US that has serious potential to negatively affect the economy. We had the FICA payroll tax increase at the beginning of the year, and the rollout of Obamacare on October 1. While I realize that most people are now looking at these two events in the rearview mirror, thinking whew – glad we got past that, I don?t share that thinking.
The FICA payroll tax increase came as a result of the heralded ?Fiscal Cliff?, the political/media collaboration that had us going to economic hell if we failed to increase federal revenues. The end result was a restoration of the employee portion of the FICA payroll tax, raising it from 5.65% to back to the pre-recessionary level of 7.65%.
That represents a tax increase on everyone making up to $113,000. That?s not a historical event ? but one that?s slowly playing out right now. That tax increases has only been in effect for a little over a year, which means it might be another year before we begin to feel the full effects of it. I believe those effects will be entirely negative. After all, it represents a reduction in income to a population that is already struggling to earn it.
Killing the economy to ?save? Social Security won?t save Social Security.
Obamacare is Part II of The Double Threat. Since that has only been in effect for a few months, it?s safe to say that we still have no clue how that will play out economically. The law is so far-reaching, and so poorly understood, that we have good reason to believe that it will be negative as well.
I?m on record as saying that there?s a lot in Obamacare that I really like. But the sweeping nature of law and the fact that it seems to have ignored economics, doesn?t bode well for the economy. We?re already starting to see negative changes in employment patterns, but my guess is that the real damage to the economy is still in front of us.
What do you think?
Riots in Thailand and Ukraine – Will Russia move in?
We never want to make too much out of events playing out in any one country, but there does seem to be a rising level of unrest in several corners of the globe. Even the mainstream media is conceding economic slowdowns in countries as significant as China, India and Brazil. And the woes being felt in the Eurozone are practically standard media fare.
The past couple of years have seen civil unrest break out in various places in the world, including Europe. The most recent trouble spots are Thailand and Ukraine. Ukraine is particularly troublesome. It sits to the southwest of Russia, and was a critical component of the former USSR.
I?m not predicting this ? only bring up the possibility ? but it is not inconceivable that the Russian military could roll into Ukraine on the heels of the winter Olympics.
Shortly after the fall of the USSR I met a gentleman ? an engineer ? who was from Russia. When I asked him his opinion of how Russia would fare post-USSR, his only comment was ?Russia without the Ukraine can?t survive as a superpower.? He went on to supply various details as to why this is true, but his comment seems especially relevant right now.
I can see Russia invading Ukraine, and at least loosely reincorporating it under some quasi-unification scheme. They could move in under the pretext that the country is coming unglued, and they can?t tolerate an unstable situation developing in a neighboring country. Russia does have that history.
Will it happen? We have to hope not, but it is a possibility. And one that, should it play out, could alter the balance of power in the world, as well as the general sense that peace is the order of the day. That will have repercussions far beyond Ukraine.
Pension troubles all over the place
If current troubles aren?t disturbing enough, there?s the backdrop of under-funded pensions, particularly in the public sector. At least 10 states are facing seriously under-funded pensions, and are looking at tax increases and various schemes to fix the problem. Meanwhile, there are problems with Social Security that are hardly making the front page.
Either Social Security and public pensions have over-promised benefits, or the economy is no longer capable of delivering the type of tax revenues that are necessary to support those promises. Worse, all of this is occurring after nearly 5 years of a bull market in stocks. The brings up the question, how much worse will this get when the market goes into a downturn?
And speaking of the stock market?
Bubbles, bubbles and more bubbles
Whatever good news there is on the pension front ? let?s say the 40 states that aren?t in as bad shape as the drowning 10 ? it all hinges on the stock market and the returns it provides. And that?s an issue in itself.
I realize that we?re at a time when complacency over the bull market is at record levels, but even the optimist has to admit that this market has had quite a run. How much higher can the market go, particularly considering that the good news on interest rates is almost certainly behind us.
For the past few years, the stock market has been ignoring bad news, focusing instead on low interest rates and trusting in the power of the Federal Reserve to keep the liquidity coming. It has completely decoupled itself from the real economy. But sooner or later the market will react to the fundamentals, and when it does, it is likely to overreact on the downside.
That won?t just affect public pensions, but also 401(k) and IRA plans. That?s virtually the entire retirement universe for both the corporate and individual sectors. A lot of people are laboring under the delusion that double digit returns will enable them to early retire, like within the next 10 years. We?ll have to see how that works.
Right now, too much confidence is being placed in the stock market. Once it goes bust, it might break the fragile confidence that has enabled the economy to make the feeble progress that it has since 2009.
We can never forget ? especially during bull markets ? that the stock market is an investment venue that has been historically notorious for boom and bust cycles. Since we have been in a boom cycle for the past few years, I think we can all figure out what?s likely to happen next. If you doubt it, just recount the 2000 – 2002 and 2007 – 2009 crashes.
What?s the Average Joe or Jane to do?
Okay, these are all macroeconomic problems that none of us has any control over. What can we do on a personal level?
Since we don?t have a crystal ball, and can?t know how things will play out, the best we can do is formulate a general strategy. Here are my suggestions:
- Get liquid – Increase your savings even if that means liquidating some investments. Millions of people lost their homes after the mortgage meltdown for lack of a few thousand dollars in cash. Don?t put yourself in that position.
- Cut back on your stock positions – The more you have invested in stocks, the bigger hit you?ll take when the inevitable reversal comes. You can reduce that risk right now. Also, shift your stock portfolio focus to dividend growth and income investing. That will provide a cash flow and minimize price declines.
- Cut your spending – This is a another aspect of getting liquid. By cutting your spending, you free up money for savings and debt reduction.
- Eliminate any debt you can – If you have a lot of debt, you?ll have to think strategically. Payoff the most important loans first ? particularly car loans. Not only will that eliminate a significant payment, but it also eliminates the possibility of losing your car for non-payment. You can?t be jobless and car-less at the same time.
- Seriously consider self-employment – During the 2007 – 2009 recession, and even the years after, it was almost impossible to get a job of any type. It may be worse in the next go round since the job market is still wobbly. The best insulation against this is self-employment. Even a side business can help, since it will enable you to take a lower paying job if you have to.
Call me a pessimist if you want, but stock market crashes and recessions happen every few years. Right now we?re about due – and the background factors suggest that the next one could be especially severe.
Do you get a sense that were on the verge of a major economic shift? If so, would do you think we should be doing to prepare for it?