double dip recession
With the recent action taken to downgrade our credit rating by Standard & Poor’s (S&P) and the significant decline in stocks over the last few days, I fired over a few questions to Joe Magyer, a financial advisor at The Motley Fool, UGA grad and friend. Hopefully, this will help you make at least some sense of what is going on right now. Also, make sure to check out Joe’s recent post, The 60-Second Guide to Recession-Proof Investing.
Q: What do you make of the downgrading in the United States’ credit rating?
JM: It is an embarrassment for our country, a blow to consumer confidence, and might ultimately cost us dearly later on. I can’t say I’m terribly surprised that Standard & Poor’s chose to downgrade the U.S, though. They drew a line in the sand when they said they’d want to see $4 trillion in cuts and our leaders didn’t deliver. Not that I give much credence to ratings agencies’ opinions to begin with. Collectively, they’re reactionary and fairly lemming-like.
Q: It doesn’t seem like anyone was happy with the deal worked out between the White House and Congress, but it only seemed like a matter of time before a credit agency like S&P took this step given that the long-term issues with the budget were not addressed.
JM: This is the first of several awkward debt dances we’ll be doing in the years ahead. The latest deal doesn’t come close to solving our longer-term issues. Namely, cutting entitlements. The sooner our elected officials can rip the band-aid off the better, but I expect we’ll keep seeing more political gamesmanship and less progress.
Yesterday wasn’t a good day on Wall Street. The Dow Jones dropped nearly 400 points — at one point during the day it had dropped 500 points — on a growing feeling that the economy is falling into another recession, problems in Europe, a feeling of unease towards the Federal Reserve’s latest monetary trick:
Stocks came off their worst levels, but still finished sharply lower Thursday in heavy-volume trading as a gloomy outlook from the Federal Reserve in addition to ongoing economic jitters fueled concerns of a recession.
The Dow Jones Industrial Average plunged 391.01 points, or 3.51 percent, to finish at 10,733.83, led by United Tech, Caterpillar and Alcoa, but still finished above its August closing low of 10,719.94. The blue-chip index skid 528 points in its intraday low.
The blue-chip index is on track for its worst week in almost three years.
The S&P 500 plummeted 37.20 points, or 3.19 percent, to close at 1,129.56 after flirting with its key technical support level of 1,120. The Nasdaq declined 82.52 points, or 3.25 percent, to end at 2,455.67.
The Fed announced it would launch a new $400 billion program in a move to rebalance its $2.87 trillion portfolio—a version of the widely expected Operation Twist—by selling shorter-term notes and using those funds to purchase longer-dated Treasurys.
Yesterday, I posted an article by Art Laffer about the chances of a double-dip recession due to the expiration of the Bush tax cuts in 2011. Before I go any further, it’s worth noting that Laffer, a Keynesian, tends to be more political in his work. He toes the party line at almost all costs.
Perry is referring to the recent model released by the Federal Reserve Bank of New York, which paints a rosy picture of the economy:
The Fed’s model (data here) shows that the recession probability peaked during the October 2007 to April 2008 period at around 35-40%, and has been declining since then in almost every month. For May 2010, the recession probability is only 0.17% (about 1/6 of 1%) and by a year from now in May of next year the recession probability is even lower, at only 0.12%.
According to the NY Fed Treasury Spread model, the recession ended sometime in middle of 2009, and the chances of a double-dip recession through May of 2011 are essentially zero.
Fair enough. Federal Reserve Chairman Ben Bernanke says the economy is recovering, just slowly. He was also blindsided by the recession that hit us in 2008.
Art Laffer is predicting a recession next year, after the Bush tax cuts expire:
On or about Jan. 1, 2011, federal, state and local tax rates are scheduled to rise quite sharply. President George W. Bush’s tax cuts expire on that date, meaning that the highest federal personal income tax rate will go 39.6% from 35%, the highest federal dividend tax rate pops up to 39.6% from 15%, the capital gains tax rate to 20% from 15%, and the estate tax rate to 55% from zero. Lots and lots of other changes will also occur as a result of the sunset provision in the Bush tax cuts.
Tax rates have been and will be raised on income earned from off-shore investments. Payroll taxes are already scheduled to rise in 2013 and the Alternative Minimum Tax (AMT) will be digging deeper and deeper into middle-income taxpayers. And there’s always the celebrated tax increase on Cadillac health care plans. State and local tax rates are also going up in 2011 as they did in 2010. Tax rate increases next year are everywhere.
Now, if people know tax rates will be higher next year than they are this year, what will those people do this year? They will shift production and income out of next year into this year to the extent possible. As a result, income this year has already been inflated above where it otherwise should be and next year, 2011, income will be lower than it otherwise should be.