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Debt

Don't Get Stung by President Obama's Deficit-Reduction Plans

In the last 10 days, U.S. President Barack Obama has unveiled three distinct deficit-reduction plans to solve the nation's economic problems.

While all three have their good points, each has its own set of problems, too – including the time-consuming political firestorm we can expect to see as the plans are debated in Congress.

We can make some educated guesses about how this will all play out – and how the final plans will help or hurt the American economy. But the bottom line is that you as an investor can't wait to see how the deficit-reduction saga ends: You need to take action now.

So let's take a look at the proposals, the likely outcomes – and the moves you need to make immediately.

A Trio of Deficit-Reduction Plans

President Obama has unveiled three overhaul plans for the U.S. economy – a "jobs" plan, an "offset" plan and a "deficit-reduction" plan.

Of the three, the "offset plan" that calls for reductions in tax deductions is clearly the best. But there are some good ideas in the other deficit-reduction plans, too – not to mention a couple of real stinkers.

Here's a look at each of the three plans – the good, the bad … and the downright ugly.

The "Jobs" Plan: President Obama's jobs plan is a mix of spending on infrastructure and providing aid to state and local governments, both of which were tried in 2009 and didn't work.

Government infrastructure spending is appallingly expensive in the United States – in fact, it costs more than twice as much here as anywhere else – because of the additional restrictions on its design and labor usage.

However, the Obama jobs plan also included a 3% reduction in employees' Social Security contributions (expanding and extending the current one-year reduction of 2%). Finally, it included a 3% reduction in employers' Social Security contributions, but only for wage bills up to $5 million.

For me, it's the last provision that made most sense and should be extended. Reducing employers' Social Security contributions by 3% reduces the cost of labor – which should expand the demand for it.

Look at it this way: If the "price elasticity" of labor is 50% (estimates for this piece of economic jargon are all over the place, but 50% is about the midpoint), then a full 3% reduction in labor costs should increase demand for labor by 1.5%, or about 2.2 million jobs.

That would reduce the unemployment rate by about 1.2%, taking it from 9.1% to 7.9%. To me, that's well worth doing.

Naturally, the Social Security trust fund can't afford to do this every year, but it should certainly be done for two years, because employer-hiring decisions take time to implement (and because U.S. unemployment still will be higher than we'd like in 2013).

But that's not all. There should be no "Mickey Mouse" restrictions to $5 million payrolls – it's just as important to encourage hiring at McDonald's (NYSE: MCD) or Wal-Mart (NYSE: WMT) as it is to promote hiring at the local corner store.

The cost of this would be about $300 billion, and would be evenly split between 2012 and 2013.

This alone is such a good idea that you could probably abandon the rest of the so-called "stimulus."

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How Greece's Debt Issues Are Becoming a Global "Black Hole"

The extremely volatile markets of late stem in part from news suggesting Greece's debt issues have made a default imminent – creating a global black hole that's sucking in a growing number of other economies with it.

Default fears intensified last Friday when European finance ministers announced they would delay a decision on whether or not Greece was eligible for its sixth tranche of bailout funds. Greece was scheduled to get the next $11 billion (8 billion euros) installment of its $152.6 billion (110 billion euros) aid package by the end of September, but now must wait at least until October.

European Union (EU) and International Monetary Fund (IMF) inspectors met with Greek Finance Minister Evangelos Venizelos last night to evaluate the country's progress with austerity measures. Greece agreed to reduce its deficit to 7.5% of gross domestic product (GDP) this year, and below 3% by 2014 in order to receive bailouts from the IMF and other euro nations.

But investors are afraid the country will run out of cash before a bailout decision is reached.

Greece may not be going down to a Trojan-level defeat in the next few days, or even weeks, but there is little doubt that the country cannot afford to remain harnessed to the euro. It faces almost certain default at this point, sad to say, which means that some big banks, shareholders and bondholders are going to suffer.

Perhaps those Eurozone critics who said that a currency union not backed by taxation or bond-issuing authority was a bad idea should have been heeded. Then countries like Greece would not have been encouraged into a currency union that's an ill-suited match for its unique economy, history and ambition.

Now the critics are being proven largely right, unfortunately.

The most dangerous thing is new evidence that the debt crisis continues to spread.

Looks like France is headed down the same path as Italy and Spain. According to a Bloomberg News story last week, France may need new austerity measures to avoid a bond sell-off and credit rating downgrade.

It seems that Nicolas Sarkozy is the new Silvio Berlusconi.

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Seven Ways Washington Can Spur Private Sector Growth

The U.S. economy is sputtering, and it's no secret why: The government is standing in the way of private sector growth.

Second-quarter gross domestic product (GDP) growth was revised down to 1.0%. That means the economy grew at an average rate of 0.7% in the first half. That's pathetic.

Keynesians will say that without government intervention, we wouldn't even have seen that meager advance. But in reality, the government's intrusion into the private sector has stunted growth.

And truly, when you look at the harassment it is suffering, and at the output it is producing, the private sector actually has been remarkably resilient. If only the government would keep out of the way, growth might get onto a decent track during the rest of the year, and at some point people might get their jobs back.

As I discussed last week, there is a precedent for this statement.

When you look at output of the private sector during the 1930s, its most vigorous recovery was in 1939-40. And it was caused not by any good government policies but simply by the end of bad ones. The Republicans won a huge victory in the 1938 mid-term elections, which did not allow them to make policy but was enough to block the endlessly inventive and expensive experiments of the New Deal.

That success could be repeated now.

The private sector is still growing, albeit not very quickly. It expanded 1.9% in the first quarter and 1.4% in the second. In both quarters, government shrank slightly, mostly at the state and local level, making GDP growth even more sluggish than gross private product (GPP) growth.

More importantly, if you consider the handicaps under which the private sector is operating, it becomes clear that the private sector is capable of even more.
Specifically, there are seven things the government could do to jumpstart the U.S. economy by simply getting out of the way of the private sector:

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Bernanke's Jackson Hole Speech: Why QE3 Won't Spell Relief

U.S. Federal Reserve Chairman Ben S. Bernanke has a choice to make this morning (Friday) before giving his Jackson Hole speech.

And he can't win either way.

Bernanke can telegraph a third round of quantitative easing (QE3), which most economists believe would at best be ineffective. Or he could do nothing to reassure the markets that have already priced in another $500 billion to $600 billion of central bank U.S. Treasury purchases.

In either case, the outcome won't be pretty.

Many analysts already have questioned the effectiveness of QE1 and QE2, and even the ones that don't are pessimistic about the potential outcome of QE3.

Money Morning Chief Investment Strategist Keith Fitz-Gerald said that although the markets may be looking for QE3, it would be a bad idea.

"It has never worked since the dawn of recorded time and it will not work now," Money Morning Chief Investment Strategist Keith Fitz-Gerald said on the Fox Business program "Varney and Co." "You cannot debase your currency and work your way out of this for anything but a short-term basis."

However, should Bernanke indicate the Fed is not considering QE3, the markets – which have risen about 5% this week — could choke on the news.

"The market's sending a signal to Bernanke saying, 'We want QE3 and we want it this week, or we're going to hammer you and the market will get absolutely killed,'" Keith Springer, president of Springer Financial Advisory, told CNBC.com. "The stock market is addicted to QE."

Third Time the Charm?

Some observers viewed the week's glum economic reports on housing, manufacturing and unemployment as possible catalysts for Fed action.

"It's almost as if negative news is being priced in as something positive because it underscores the argument that the Fed needs to do something," Abigail Huffman, director of research for Russell Investments, told The Wall Street Journal. "People are hedging their bets. They're hoping for the best and positioning for the worst."

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A U.S. Double-Dip Recession? Why George Soros is Wrong

In an interview with Der Spiegel, investing legend George Soros says the Standard & Poor's downgrade of the U.S. credit rating means that it's more likely than ever there will be a U.S. double-dip recession.

But here's the thing.

He's wrong.

As much as we respect Soros as an investor, barring an outside shock, a U.S. double-dip recession isn't in the cards. Not for now, at least.

And we can prove it.

To find out how, you need to read Martin Hutchinson's analysis in today's (Tuesday's) issue of Private Briefing.

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European Union Debt Crisis Stings France, Putting U.S. Banks at Risk

While investors in the United States have been preoccupied with the debt-ceiling crisis and volatile stock markets, the European Union debt crisis has worsened.

Now France is under suspicion, and if its debt troubles spiral out of control, then there's a good chance the country will take U.S. banks down with it.

Despite denials from the major ratings agencies, some believe France could be in danger of losing its AAA credit rating, just as the United States did recently.

In fact, it was Standard & Poor's unprecedented downgrade of the United States that put investors on notice that no nation was safe. France became a target because many of its large banks hold a lot of debt from troubled nations like Greece, and because France has a lot of debt of its own.

The cost of insuring French sovereign debt via credit default swaps edged up last week as rumors swirled and concerns accelerated.

French sovereign debt has grown alarmingly quickly, rising from just 64% of its gross domestic product (GDP) in 2007 to 85.3% of GDP this year, according to International Monetary Fund (IMF) estimates.

A weakening French economy – on Friday the French statistics office reported that second quarter GDP growth was zero – and inadequate government policies have added to investor jitters about the country's ability to repay its debt.

"We've been really cautious, and the sovereign crisis is now escalating," Philip Finch, global bank strategist for UBS AG (NYSE: UBS), told The New York Times. "It boils down to a crisis of confidence. We haven't seen policy makers come out with a plan that is viewed as comprehensive, coordinated and credible."

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U.S. AA+ Credit Rating Downgrade: Here's The Worst-Case Scenario… And How To Protect Your Wealth

If there's a "worst-case scenario" for this whole credit downgrade, this is it.

U.S. stocks have plummeted with the Standard & Poor's downgrade, but the final results of the AA+ credit rating could be much, much worse.

After studying everything that could happen due to the downgrade of the United States' top-tier AAA credit rating, and the potential default on its debt, we found a scenario that would result in forced asset sales so widespread that global stock-and-bond markets would plunge – and economies around the world would crash.

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Why a U.S. Default Will Be a Good Thing

Now that Standard & Poor's has finally slashed its U.S. credit rating, it's more apparent than ever that a U.S. default is imminent.

So if you're at all panicked by S&P's decision to downgrade the country's top-tier credit rating – and the resultant freefall in U.S. stock prices – brace yourself: It's going to get a lot worse before it gets better.

But make no mistake, it will get better.

In fact, at this point, a U.S. default is the only conceivable remedy to our debt affliction.

Here's why …

The Wrong Road

The United States has been able to coast on its top -tier credit rating for far too long. The truth is, this country stopped being a AAA credit risk in early 2007.

That's when the Bush administration's excess spending and military forays into the Middle East sent us down the wrong road and ultimately drove the fiscal 2008 federal deficit to more than $400 billion. That's despite the fact that the economy was at the top of an economic boom at the time.

It's true that our fiscal position has grown substantially worse since then, but that's mainly because of the G reat R ecession of 2008-09.

Even if an imaginary amalgam of Calvin Coolidge and Bill Clinton had been in the White House since 2008, inheriting the overspending already built into the system, the federal deficit still would have reached $700 billion to $800 billion over the last few years.

Just the bailouts of Fannie Mae, Freddie Mac, General Motors Co. (NYSE: GM) and Chrysler would have added enough to the structural costs of recession to push the arithmetic off kilter.

The Bush administration's additional spending in 2008, U.S. President Barack Obama's $800 billion-plus of "stimulus," and the g rotesque addiction that Congress continues to have to subsidies for farmers, ethanol, and idiotic "green" energy projects have all made the position worse. But they only account for about half of the annual deficit.

Of course, while recent political decisions don't bear much responsibility for the current lousy U.S. position, our current crop of politicians have been – and will continue to be – ineffective in their attempts to emerge from it.

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Gold Prices Hit Record High After S&P Downgrade – Are Poised to Double

Gold prices hit a record high of $1,718 an ounce in intraday trading yesterday (Monday) in response to Standard & Poor's downgrade of the U.S. credit rating, and the continuing drumbeat of dreary global economic news will keep pushing the yellow metal higher.

In fact, Money Morning Contributing Editor Peter Krauth reiterated his belief that gold prices will more than double from current levels.

"I expect gold to reach $5,000 before this bull market peaks," Krauth said. "I'm very open to the possibility that gold could correct from here, but I'd expect that to be nothing more than a short-term pullback."

Following through on a months-long threat, S&P cut the U.S credit rating to AA+ from AAA late Friday, sending global stock markets tumbling and a flood of investors to one of the few safe havens available – gold.

"The S&P downgrade adds to concerns that investors have in the safety of U.S.- issued debt," Krauth said, pointing out that Treasuries are "considered to be the safest in the world because of their previously unblemished AAA rating and their liquidity. When doubt is cast on such an important and ubiquitous investment instrument, it's no surprise that gold, a traditional safe haven dating back millennia, is going to be a beneficiary."

Although it had already risen 15% for the year as of Friday, the appeal of gold remains high among investors worried about sovereign debt problems in the United States and Europe, as well as a U.S. recovery that looks like it may tip into a double-dip recession.

"The surge in gold is a knee-jerk reaction to the downgrade and could prompt profit-taking, but concerns of slowing economic activity in the U.S. and the lack of concise action to tame its debt levels will likely see more diversification from U.S. assets, boosting demand for the ultimate safe haven," FastMarkets analyst James Moore told the Wall Street Journal.

Gold on the Comex division of the New York Mercantile Exchange soared $66.40, a 4% pop, in overnight electronic trading Sunday night to a record $1,718.20 an ounce. After slipping below $1,700 in the morning, S&P's follow-up announcement that it had also downgraded the credit ratings of mortgage giants Fannie Mae and Freddie Mac drove gold to $1,715.50 by 4 p.m.

Yet gold remains well below its inflation-adjusted peak set in 1980, when it sold for $850 an ounce – the equivalent of about $2,400 an ounce today.

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