David Rosenberg, Gluskin Sheff: PARTING OF THE CLOUDS?
Austerity is not some dirty nine-letter word as the socialists in Europe would have you believe. It is all about living within your means and living up to your commitments.
There is some good news in the United States with respect to this topic.
Wisconsin and the controversial Governor Scott Walker and his electoral victory grabbed the headlines last week. But the really big development took place in California where San Diego, by a two-thirds majority vote, approved a plan that puts new city workers on a private sector-type retirement fund and a six-year wage freeze for current employees. San Jose also saw a 70% majority pass of a reform bill that offers civil servants two choices: contribute more to fund their pensions or be willing to accept a cut in benefits.
As last Thursday's Investor's Business Daily aptly put it in its lead editorial piece:
San Diego, and San Jose are emblematic of the tidal wave of pension liabilities faced by cities across California — and, indeed, the U.S. It's unsustainable...if liberal California recognizes the depths of its public-sector union problems, no doubt others will too.
Amen to that.
I've been saying for a while that if Canada could pull back from the brink of fiscal insanity in the early 1990s, then certainly America can do it today. Don't wait for a crisis to shock you into it as we did — it makes the transition to budgetary integrity much tougher. There are more than 80 million millennials out there — kids between the ages of new-born to twenty. This cohort (our future) is even bigger than the boomers. It is imperative that we don't saddle them with a debt noose around their necks and no job prospects to speak of. As it stands, the average college student has an average debt load of $30,000 and the male unemployment rate for those between 20 and 24 years old is 14%. That, my friends, is the statistic that keeps me up most at night because the longer it stays that high, the more one should be concerned over social stability.
Mitt Romney seems to have taken over in the polls and is the candidate who is taking the high road so far in this campaign. He managed to raise more money in May than the President — an impressive feat (nearly $77 million dollars versus $60 million for President Obama). To be sure, it is difficult to unseat a sitting president but when it has happened, it was because of a deteriorating economic backdrop. This economy was already growing slowly and is about to slow down even more as the European recession and Asian softening hit our exports and production data in coming months.
The uncertainty over the extent of next year's tax bite is also likely to cause households and businesses to pull spending back and raise cash, at the margin. All this means the economy won't turn around in time for Mr. Obama — by the time the election rolls around, we could be talking about a 9% unemployment rate, especially with those on emergency jobless benefits getting termed out and as such will be compelled to come into the workforce to engage in a job search (either that or move into your brother-in-law's basement -- if he'll let you).
In any event, it's all about resolve, courage, discipline ... and the right political moment to strike. Canada has the benefit of granting governments on occasion the benefit of running the country with a majority. The advantage of a parliamentary system — so long as the party in power doesn't blow it. Canada is blessed with that today — a Conservative majority with a pro-business agenda — as it was in the 1990s with the Liberals under the leadership of Jean Chretien and Paul Martin. Stalwarts who were willing to part from their populist election campaign in 1993 and embark on the road towards fiscal austerity.
It wasn't easy— cuts to health and education. Privatization. Various revenue- raising initiatives. Keeping the national sales tax that was imposed by the prior Mulroney government (which deserves a lot of credit for blazing the trail). Means-testing Old Age Security and the Guaranteed Income Supplement. Cutbacks to the civil service and wage freezes. Raising the retirement age too in order to curtail bloated actuarial pension liabilities. And a move towards privately delivered medical care. All in formerly Socialist Canada — what Lord Black once labeled a 'Banana Republic' (not exactly the right climate to grow the fruit, mind you).
The United States can do the same. But having one party in power at both the executive and legislative levels would be necessary since the divide between the GOP and the Democrats is far too wide to get anything done. A lot can be accomplished, even in a two-year span. The Republicans look set to take the Senate and reclaim the House, so it would stand to reason that those who believe this is a time for courageous action to replace gridlock, would be opting for Mr. Romney.
No candidate is perfect, but let's just say, from a purely economics standpoint, that Mitt, based on his background as a businessman, understands the time-worn link between profits and jobs. And the U.S., to be sure, has a jobs crisis. Solve that, and you'll be surprised at how the other ills from social divisiveness to health care funding to government revenues will be resolved.
This will thus require a re-write of the tax code, a highly inefficient tax code that promotes consumption at the expense of savings and investment — investment that is at the root of future productivity growth and in turn the critical driver of our standard-of-living. This means "no" to higher top marginal tax rates — it is imperative to keep the incentive system for success fully intact. You can't mess with that. Better to build public support for and enact a national sales tax like Canada did over two decades ago. Was it controversial? Yes. Did the retailer lobby picket the parliament buildings and make a whole lot of noise? Absolutely. But in the end, it allowed for lower marginal rates and over time, a declining path for the unemployment rate — which is now far below the level prevailing in the U.S. Tax consumption and this will also fall on foreign producers and help narrow the bloated trade deficit. Encourage the development of natural gas and finally wean us off of oil import dependency and the United States could again emerge as a nation with a trade surplus, deserving of being the world's reserve currency. Reducing tax breaks and loopholes is necessary — especially those that favour housing. Having a system that encourages a shift in the nation's resources to basically an unproductive asset is plain wrong — who else has both mortgage interest deductible and tax-free capital gains on the sale of the principal residence? Not just wrong but wasteful.
In a world of finite financial resources, it is important to not have policies that encourage resource mis-allocation. Studies from decades past indicating that homeowners are better citizens than renters have already been proven to be out-dated. So the National Retail Federation would undoubtedly throw a fit over a VAT and the National Association of Homebuilders would rattle the cage over the phasing-out of the tax goodies that promote overconsumption of an unproductive asset — simply put, a house is a large consumer durable good, it's a place we live and that's about it — but if replaced by a system that encourages growth in the private sector capital stock, the job creation that will follow should quiet down these lobby groups.
At the same time, there is little doubt that "entitlements" are going to have to be amended — one first step would be to get rid of that word. The only "entitlement" that really is or should be in America is a fair shot at the yellow brick road — not a cheque from Uncle Sam.
Resolve. Courage. Discipline. Shared sacrifice. I can sense it coming down the pike. As was the case with Ronald Reagan, just having a clear and coherent fiscal plan will part the clouds of uncertainty and encourage capital to be put at risk rather than sit as idle unproductive cash on corporate balance sheets.
We've seen this before, by the way. The rewrite of the tax code during the Reagan era wasn't legislated until 1986 and this was the reform that took sky- high top marginal rates on a declining path. But the bottom of the economy and the market was in 1982 as households and businesses responded ahead of the fact to a new level of certainty and confidence as it pertained to the outlook for fiscal policy. There is no shortage of books on behavioral economics that deal with how "expectations" play a crucial role in spending patterns today.
I may be cautious on the outlook for risk assets and cyclical securities over the near- and intermediate term. But change is always at the margin. And it usually starts in the political sphere. Within that realm, it is the local levels that tend to lead reforms at the national level. And that we could see the pension reforms take hold in California of all states — hey, isn't that our "Greece"? — is a real bellwether. The temptation to stay bearish at the peak level of desperation in 1982 must have been strong, but superimposing the experience of the prior 16 years of cost-push inflation, excessive regulation, extreme labour power, the costs of the Vietnam War (at every level), economic sclerosis and labour immobility to the next 16 years would have been a colossal error, because as it turned out, the 1980s and 90s belonged to America. Fancy that. But you couldn't have sold that story in 1982, that much is for sure.
The future is brighter than you think. This does not mean we will not have another recession, by the way — we had a doozy within the first two years of the fabled Reagan presidency, but we endured nonetheless and came out stronger on the other side once the inflationary excesses of the day were purged (today, it is a case of curing a deflationary debt deleveraging). The structural tax reforms, a new approach for dealing with the Soviet Union, and the air traffic comptroller lockout (which forever changed management-union relations) ultimately ushered in a prolonged period of prosperity that would have seemed like a dream in the 1970s when families had to line up on different days of the week to fill their cars up with gas. What Reagan managed to do was instill confidence with a coherent, credible and cogent strategy that gave people — who make up the economy — a higher degree of certainty over the future. I cannot stress how important it is for any government to ensure at all times that households and businesses have as much clarity over the policy outlook as possible. That makes it easier to plan ahead. And in turn, it leads to better economic results.
I'm noticing a certain degree of despair these days, just as I am getting enthusiastic about the future. Much depends on what happens on November 6th and between now and then we still have the European mess, China hard landing risks and the U.S. debt ceiling issue to confront. Be that as it may, those with some dry powder on hand will have their clients in a solid position to take advantage of whatever forced "panic" selling takes place.
For the record, I do see a light at the end of the dark tunnel. Don't be surprised if I end up turning bullish ahead of the pack — though it may not be until the like of my good friend, Jim Paulsen, is hiding under his desk screaming "uncle"! But the Rosenberg shift to perma-bull status — I was there in the 80s and 90s, but obscurity got in the way — could come as early as Thanksgiving.
I'm so excited I just can't hide it. But for now, I'm keeping the powder dry.