What the “Fiscal Cliff” Means for You

Debt crisisOn the historic day of August 5, 2011, when Standard and Poor’s (S&P) downgraded the U.S.’s credit rating for the first time in its history, the world took notice.

Today, credit reporting agencies Moody’s and Fitch maintain their AAA credit rating on U.S. government debt, but that could soon change.

The Fitch credit rating agency noted last week that if the U.S. does not deal with its deficits with a credible plan soon, Fitch will remove the AAA status from the U.S in 2013 (source: Reuters, June 8, 2012).

Before Fitch can remove the U.S. AAA credit rating, it needs to have a negative credit rating on U.S. government debt; which the credit rating agency indeed does. Moody’s also has a negative credit rating on U.S. government debt; with Moody’s also being a risk for downgrading our country within the next year.

Moody’s echoes the sentiment of Fitch using strong language in its recent reports on U.S. credit, harping on the warning that the U.S. government needs to get its house in order and cut U.S. government debt.

The reason why the downgrade of the reserve currency of the world could become reality in 2013 is the “fiscal cliff.”

I have written in these pages about the coming government spending cuts and reinstatement of taxes originally enacted to help us out of the financial crisis. On January 1, 2013, these spending initiatives and tax cuts are set to expire.

Even Ben Bernanke, in his latest testimony to Congress, cited the fiscal cliff as most likely sending the U.S. into a recession. With the fiscal cliff representing three percent of gross domestic product (GDP) and the U.S. growing at roughly two percent, this leaves us with minus one percent: a.k.a. recession.

Sure, we’ll all feel great about extending the tax cuts and government spending initiatives to help the U.S. economy. But this will almost guarantee that 2013 will be the fifth consecutive year of trillion-dollar U.S. government deficits…something that has not gone unnoticed by the credit rating agencies.

Moody’s and Fitch have explicitly said that if these tax cuts and spending initiatives are not removed, as is the plan now, both credit rating agencies would downgrade U.S. government debt.

Although this may not seem alarming to many people, we must remember: the U.S. dollar would become the reserve currency of the world without the highest credit rating in the world. Other countries that use the U.S. dollar as the reserve currency could, on the back of all of the major credit rating agencies agreeing that the U.S. government debt is not worthy of the highest rating, cut back on their purchase and use of the U.S. dollar.

These countries—with China and Japan being our largest U.S. government debt buyers outside of the Federal Reserve itself—could decide that this move by the credit rating agencies means they need to rethink their approach to buying and supporting the U.S. dollar and buying U.S. government debt.

The historic downgrade of U.S. government debt looks like it could start to become common practice. With another trillion-dollar deficit looming in 2013, Fitch and Moody’s credit rating agencies will be given little choice. This does not bode well for the U.S. government trying to sell its debt or for the U.S. dollar.

This could lead to more money printing, as the Fed may be looked upon to buy more U.S. government debt, lowering the value of the U.S. dollar. The assets that appreciate the most against these factors are gold bullion and gold stocks. (See: Central Banks to Buy Another 70.3 Tonnes of Gold Bullion.)

Michael’s Personal Notes:

How wrong they were…

Many had said the crisis in the eurozone would not create an economic slowdown in the U.S. economy. However, in April, U.S. exports to the eurozone fell 11.1% from last year (source: Reuters, June 8, 2012). In 2011, the eurozone was the second largest export market for the U.S.

Couple the U.S.’s big drop in exports to the eurozone with the fact China is experiencing its own economic slowdown because of the eurozone, which is affecting our exports to China, and our exports get a double-whammy hit.

U.S. exports to China fell 14% in April when compared to last year. This statistic is a big deal, because, over the last three years, the only bright side to U.S. GDP growth—and what helped counteract the economic slowdown—was the fact that U.S. exports picked up overseas…and a lot of that was due to Asia.

Where does that leave U.S. GDP growth now?

As we started screaming early this year, the financial crisis in the eurozone will have a huge impact on the U.S. economic slowdown.

With fewer exports and weak economic numbers being released here in the U.S., imports to the U.S. fell 1.7% in April from last April’s level. If the U.S. is taking in fewer imports, we see this is a direct reflection of the economic slowdown here in the U.S.

Capital goods and industrial supplies and materials were the areas that were impacted the most by the decline in U.S. April imports. As I reported earlier, the U.S. durable goods numbers for April were also very weak…bringing the economic slowdown argument here in the U.S. full circle.

What is more troubling about the strong decline in capital goods and industrial supplies and materials is that these areas are what drive capital investment. And capital investment is what drives job creation and economic growth.

The news gets worse. Wholesale inventories rose more than expected in April, hitting a record $483.5 billion in April. Record inventory on the shelves means fewer sales. Fewer sales mean decreased consumer spending and more proof of an economic slowdown.

Increased U.S. exports to China would have been nice to counteract our domestic slowdown, but the eurozone created an economic slowdown in China.

The chances of the U.S. falling back into recession this year are increasing dramatically each passing day. (See: The Inevitable U.S. Recession: Part II Starts.)

Where the Market Stands; Where it’s Headed:

March 9, 2009, is a historic day to stock market buffs like me. On that day, the Dow Jones Industrial completed the first phase of a new long-term secular bear market. On that day, the Dow Jones Industrial Average bottomed out at 6,440—a huge drop of 55% from the all-time high set in October 2007.

Phase II of the secular bear market (the “bounce) started on March 9, 2009. It took the Dow Jones Industrial Average to post-crash high of 13,338.66 on May 1, 2012. The big question now: Is Phase II of the bear market over? My belief is that we may be there.

America is finding out fast that the economy has been propped up the last four years by artificially low interest rates, unprecedented government debt, and a record expansion of the money supply. Europe is in crisis. China may be headed for a hard landing of its economy. Corporate America cannot escape the next economic down leg. Phase III of the bear market will be devastating.

But, as has been the norm over the past three to four years, the government and the Fed will not let the market “go gentle into that good night.” They will fight the bear market with more debt, more money printing. This will give the market a boost, hence why I’m not quite ready to throw in the towel yet on the bear market rally.

What He Said:

“I’ve been writing to my readers for the past two years claiming the decline in the U.S. property market would not be the soft landing most analysts were expecting, but rather a hard landing. My view remains unchanged. The U.S. housing bust will cut deeper and harder than most can realize today.” Michael Lombardi in PROFIT CONFIDENTIAL, June 13, 2007. While the popular media was predicting a bottoming of the real estate market in 2007 Michael was preparing his readers for worse times ahead.