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Three "Fiscal Cliff" Moves to Make Right Now

The prospects of a "Fiscal Cliff" impasse are causing more nightmares in middle class America than Freddy Krueger did on Elm Street.

But Permanent Wealth Investor Editor Martin Hutchinson has a surprisingly contrarian take on the escalating tempest.

Indeed, when the Obama Administration took a hardline stance yesterday and said it's "absolutely" willing to go over fiscal cliff unless it gets what it wants, Martin made his own feelings crystal clear.

"Let them jump," he said.

Martin's sentiment was based on economics, not politics. There's been so much fear-mongering and political obfuscation that most Americans have lost sight of what's really at stake here, Martin said during one of our talks last week.

"Bill, it's all such rubbish," the former global merchant banker told me. "As I said to you when we first started talking about what's become known as the fiscal cliff, it makes a lot of sense just to go over."

Before you grab your heart in mock horror, let us make sure you understand a key point. The feckless crew down in Washington has a lot of folks believing that this whole debate is about dodging the pain – forever. That phony safety pitch is what Martin is referencing with his "rubbish" comment.

"Some of our leaders want us to believe this debate is about avoiding the pain of higher taxes, another recession, a spike in unemployment, an inability of businesses to grow and hire," Martin said. "The truth is that there's no way to avoid the fallout from the fiscal mess this country now faces. We can either accept the pain now, or be forced to face it later. And if we wait, the pain will be far more excruciating than most Americans can even imagine."

Let's look at what Martin means.

To do that, let's use a vastly simplified version of a study by the Congressional Budget Office (CBO) – the agency that provides nonpartisan budgetary analyses to our elected lawmakers.

The term "fiscal cliff" was coined to describe what will happen if a package of Bush Administration tax reductions is permitted to expire, even as a series of spending cuts take effect.

The implication is that the U.S. economy will be shocked into recession – pushed over the "fiscal cliff." What the term doesn't convey is that there would be an accompanying reduction in the U.S. deficit of some significance.

What the CBO did was to create two scenarios – a "baseline" scenario in which the country is toppled over the cliff, and an "alternate" view in which Washington "rescues" (term is mine) America with late-in-the-game compromises.

The results may surprise you, since they run counter to the spin we're getting from Washington.
Under the alternate, or rescue, scenario, Washington dodges the fiscal cliff, most likely avoiding a near-term recession. Taxes and other revenue remain around the historical norm of about 18% of U.S. gross domestic product (GDP). But public debt rises from 69% of GDP in 2011 to 100% by 2021 and to roughly 190% by 2035.

U.S. debt as a percentage of GDP hasn't been that high since it peaked at 109% just after World War II. If we do see such a spike, you can bet it will impact the nation's ability to grow and create jobs.

In fact, a 2010 study conducted by economists Kenneth S. Rogoff of Harvard and Carmen M. Reinhart of the University of Maryland – found that for countries with debt-to-GDP ratios "above 90%, median growth rates fall by 1%, and average growth falls considerably more."

Compare that to the CBO's baseline projection, the Nightmare on Main Street scenario that the Beltway SpinMeisters want us to believe should be avoided at all costs.

By implementing the required spending cuts and letting the tax reductions expire, taxpayers would feel a bigger bite and overall federal revenue would rise to 24% of GDP. The higher revenue coupled with the lower spending would lower U.S. debt, interest payments and federal budget deficits for year.

Deficits would fall from 8.5% of GDP in 2011 to 1.2% in 2021. According to the CBO's calculations, the accumulated deficit for the 2013-2022 period would be slashed from $10 trillion to $2.3 trillion – a reduction of $7.7 trillion.

The bottom line under the CBO forecast: We'd probably see the economy slow to near-zero growth in the first half of the New Year, with a rebound to 2% or more in the second six months.

In the long run, however, the big cuts in debt issued each year, interest payments and the worrisome yearly budget shortfalls would lead to much higher growth, and would give this country the economic muscle needed to better compete with such emerging economic leaders as China.

"I agree that we'd probably have a mild recession in the near term – but it would be a mild one because we no longer face a financial crisis," Martin said. "And having a mild recession in the near term because we've taken such pro-active steps to clean up the economy is much preferable to harsher ones that will increase in both frequency and intensity down the road if we let U.S. debt become an even greater imbalance."

Even better: Slashing debt will finally solve the job-creation problem that's been plaguing this country for half a decade.

"By reducing debt, you're reducing what the government sucks out of the U.S. economy – which is very good for small businesses," he said.

So if you believe the two sides will fail to get together, resulting in an impasse that shoves the country over the fiscal cliff, what should you do to get ready? While most investors are panicking, you can celebrate the U.S. economy's good fortune – and your own as well, by making these three moves:

  1. Take Stock of U.S. Stocks: In general, U.S. stocks will likely take it on the chin. That doesn't mean you should dump stocks and run, however. It means the broad market indices will do poorly, so careful stock-picking will carry the day over set-it-and-forget it indexing. Financially sound companies with solid dividends will also stay in style.
  2. Twin Catalysts for U.S. Treasury Bonds: A reduction in debt will be good for the country's credit rating. And that upbeat outlook for America's finances will make U.S. bonds look even more attractive than the offerings of our debt-ridden counterparts overseas. At the same time, the deficit-reduction efforts will result in the U.S. government issuing less debt, reducing supply. The increase in demand coupled with the drop in supply should supercharge U.S. Treasury prices. Martin recommends the iShares Barclays 20+ Year U.S. Treasury Bond Exchange Traded Fund (NYSE: TLT).
  3. Currency King: Martin says the big winner will be the U.S. dollar. It makes complete sense: If we clean up our act so that there's more confidence in our
    economy, it follows that there will be a renewed confidence in our currency, as well. Expect the dollar to rally big against other currencies for that reason alone. Plus, the greenback has a correlation coefficient with the U.S. Standard & Poor's 500 Index of negative 0.79, meaning it moves almost perfectly opposite the direction of this key U.S. stock index (and that inverse correlation has been increasing, according to researchers with the Bespoke Investment Group). So if the S&P 500 were to fall, as Martin predicts, the dollar will rally by almost the same magnitude. To capitalize on a projected dollar rally, Martin has two suggestions – depending on how speculative you wish to be. His first suggestion is the PowerShares U.S. Dollar Index Bullish Fund (NYSE: UUP). Although this unleveraged fund tends to trade in a tight range in normal markets. But during times of panic, it can make big moves – and quite quickly, too. It shot from $22.50 to $27 in late 2008 and from $22.75 to $25.75 in a rally in early 2010. For a more-speculative play, take a look at the triple-leveraged PowerShares DB 3X Long U.S. Dollar Index Futures ETN (NYSE: UUPT).

"A shove over the fiscal cliff will create a lot of market hysteria, but those who believe that's the ultimate outcome and position themselves ahead of time will do quite nicely if that happens," Martin concluded. "And, speaking frankly, I hope that's what happens. It would certainly fix a lot of the problems the economy faces and would increase the odds for higher growth going forward. Now if we can only get them to do something about the regulatory environment, too …"

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About the Author

Before he moved into the investment-research business in 2005, William (Bill) Patalon III spent 22 years as an award-winning financial reporter, columnist, and editor. Today he is the Executive Editor and Senior Research Analyst for Money Morning. With his latest project, Private Briefing, Bill takes you "behind the scenes" of his established investment news website for a closer look at the action. Members get all the expert analysis and exclusive scoops he can't publish... and some of the most valuable picks that turn up in Bill's closed-door sessions with editors and experts.

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  1. 000058659536 | December 17, 2012

    it seems there are more analysts starting to fall in line with Harry Dents predictions…

  2. Roger Charlesworth | December 17, 2012

    Looks good to me. Come on the Fiscal Cliff!

    • (Admin) Bill Patalon | December 17, 2012

      Roger … I wanted to tip my cap to you for your supportive — and shrewd — response to this piece. And I mean that sincerely.

      Thanks for taking the time to write.

      William Patalon III
      Executive Editor
      Money Morning & Private Briefing

  3. George Kaiser | December 17, 2012

    Right on! The idea we can push the problem to the next generation is silly -it will be our problem much sooner than that, so lets face it now!

    • (Admin) Bill Patalon | December 17, 2012

      Dear George:

      Well stated….

      William Patalon III
      Executive Editor
      Money Morning & Private Briefing

  4. Larry Lawson | December 17, 2012

    Save Social Security….create a bill that requires Senators, Representatives snd all government employees that are exempt from Social Security contributions to be enrolled into the Social Security Program.
    After all these people are the ones crafting the fix for Social Security……….who better to participate in the program than the ones making the rules?

  5. Vicky York | December 17, 2012

    I would rather face a few "sparse" years, instead of passing the mess onto my children and eventually onto my grandchildren. Common 'Cliff let’s take a ride!

  6. don | December 17, 2012

    We were taught by our parents to honestly face the music when we did wrong and work at making things right. This takes discipline, patience, sacrifice and hard work.
    If we do that as a nation then we will have growth, confidence and respect from everyone.

  7. Joseph B. Violette | December 17, 2012

    Washington doesn't seem to grasp the fact that Federal spending cannot continue to spend more than it takes in without taking the Country into bankruptcy–States can't, you and I can't. So lets jump now before the cliff gets any higher! I say that even though we are retired and living, essentially, off dividends.

  8. (Admin) Bill Patalon | December 17, 2012

    Wow, folks … there are strong feelings on this topic, and you all pretty much agree with our assessment …

    Truth be told, perhaps I should actually be stating that we pretty much agree with YOU, since I suspect yours are long-held viewpoints.

    Vicky, allow me to compliment you for expressing this sentiment with a much-greater eloquence than I did. But I, too, think of my six-year-old son having to find a way to make a living, support his family, and (I hope) find general happiness while at the same time trying to punch and counter-punch his way through the mess that the budgidiots (budget-idiots) in Washington have created (and we must shoulder some of the blame, too, for not exterminating the vermin at the polls). I, too, would rather experience some pain now as opposed to making him and our other children face agony later.

    Very well stated…. thank you. I'll be in the 'Cliff ride ticket line right after you …..

    Don … couldn't agree more. My late grandparents — on my Dad's side — were products of the Great Depression. My grandfather was a railroad man. He built his own house. He paid cash for every single one of his cars. And he and my grandmother were so very careful with their finances, and were able to raise a family and live out their long retirements without financial fears.

    My parents, too, are products of that careful culture. And I know how it pains them to look at how this country is being run today, and to think of the future that their only grandson (my little boy) faces.

    We can't fix it ourselves. So we here at Money Map Press try our very best to help the small piece of the world we come in contact with (our readers) to be the best-informed and best-armed investors in the marketplace.

    In that, we're most fortunate. Because our audience consists of many folks such as you, and the others who have posted here, who share these financial values, and who I know will do their very best to prepare themselves in a way that allows them to navigate the fiscal disaster that is now inevitable.

    Keep posting, keep sharing your thoughts and views, and please feel free to pose questions, suggest columns or analyses that you'd like to see, or tell us what areas of investing, finance or economics would best help you achieve your goals.


    Respectfully yours;

    William Patalon III
    Executive Editor
    Money Morning & Private Briefing

  9. Andy Schuck | December 18, 2012

    And a side benefit, lots of people who pay NOTHING in income tax will get a bump and might finally have to put some skin in the game PLUS having to pay the full percentage of SS and Medicare tax (which has been reduced by 2%) like everyone before them have done…….YEAH, CLIFF

  10. 000037089620 | December 21, 2012

    I am still learning your system.

    You mentioned that if the two side of the Congress we will be facing falling off the cliff. Is so the U.S. stocks will suffer. The step to take is to:
    1) Get rid of 'bad' stocks and keep the 'good' dividend paying stocks (How to choose?)
    2) Buy TLT (when)
    3) Buy UUP (when)

    When to make the selling or buying? What indicators to use?

  11. Omar | December 22, 2012

    I m a complete newbie ,i have some funds to invest by 2013 .what resources you recomend in order to learn before investing especially for non US residents . i have heard that you can lose more or all your money than what you invest if the market crushes down ,and this idea might prevent me from investing in the stock markets ? what do you think think you so much .

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