Wednesday, May 12, 2010

A Flash Crash in the Shock Market

From the Desk of Joe Rollins

I received many comments concerning my post on Friday regarding the credit crisis in Europe and its impact on the U.S. stock market last week. Today the markets that sold off 5% last week rallied 4%, which I believe underscores my point on Friday that the sell off on Thursday and Friday was related to technical trading and not economics in the U.S. I fully expect more volatility in the weeks ahead – but I don’t think that will change the improving economy in the U.S.

Many of these traders apparently shorted the market on Thursday and Friday and got caught in their short positions over the weekend when the European Union approved the 750 billion euro bailout of sovereign debt in Europe. Fortunately, Rollins Financial neither bought nor sold during this period of time, and therefore, we simply suffered the ups and downs of the market, although it was still gut-wrenching to see the market selloff in such a dramatic fashion. However, when you invest for the long-term, which is what we do, you just have to accept the daily fluctuations; it’s the only way to enjoy the long-term financial gains.

In my last post, I commented regarding the dangerous economic path that the United States is on and how it emulates the economies in Europe. Even though socialism has never worked economically in the history of the financial world, the United States is seemingly bound and determined to obtain that financial goal. As the economy in Greece has proven, without incentives for advancement, the government cannot raise the amount of taxes necessary to support all of the social causes that a socialistic economy desires. The essential difference between a socialist and a capitalist economy is that a socialist economy depends upon the government to provide many of the services that the private sector would provide in a capitalist economy.

In that regard, I came across an interesting article written by David Gergen which appeared, in all places, in Sunday’s issue of Parade magazine - click here for the article. Gergen, who is a well-known political consultant and former presidential advisor in the Nixon, Ford, Reagan and Clinton administrations, makes some compelling points about how big our government is becoming, stating that:

"Public spending by federal, state and local government was 24% of the GDP in 1950, 35% before the Great Recession, and could hit 44% this year."

Clearly, public spending in all aspects of America is growing exponentially. As more and more of our GDP is run through the government, everyone will have to pay a lot more in taxes to support a larger and larger government – both federal and state.

Gergen also points out that,

"The Tax Foundation estimates that 60% of all Americans now receive more in income benefits from government than they pay into government, and that with new policy directions, the number will grow closer to 70%."

This is an interesting statistic. When the 70% level is reached, then seven out of every 10 Americans will receive more from the government than they have paid in. Arguably, there is no equality in taxation when such a large portion of the population is taking more than they are paying.

"The Tax Policy Center has found that while everyone is expected to pay payroll taxes, only 47% of American households now pay federal income taxes."

The difficult part of this particular statistic is that when taxes are raised, only 50% of the population will be incurring the tax burden. The federal government is currently spending in the neighborhood of $4 trillion per year, but it is only raising $2 trillion in revenues from all sources. It is technically impossible for 50% of the population to make up the shortfall of taxes for the additional $2 trillion. The obvious solution is that, at some point, the government is going to have to dramatically reduce its federal expenditures. While it may be possible to get the federal budget down to $3 trillion, it is impossible to get taxes up to $4 trillion.

"The European Union has agreed that it is dangerous for a country to allow its publicly held debt to exceed 60% of its GDP. The Congressional Budget Office says that the U.S. could hit 60% by the end of this year, and on its current course could hit 100% by 2020."

It’s a scary thought that the federal deficit is ballooning in such a fashion that it could potentially hit 100% of the GDP by 2020. It’s true that for a few years during President Clinton’s administration, the federal budget was actually in a surplus. I vividly remember reading in Dr. Alan Greenspan’s book that it became a concern in the Department of Treasury as to how they would even spend the surpluses. It seems like we have moved light years away from that era.

With the deficits that began in 2001 after the 9/11 terrorist attacks and the expanding wars in Iraq and Afghanistan, the deficits have exploded. Even though they were terrible under President George W. Bush, the current administration has quadrupled the size of the deficits. It should be fairly clear to all Americans that we cannot continue to run these deficits and we cannot raise taxes to balance the current budget. The only viable solution is to reduce expenses dramatically and reduce the size of government to fit the amount of taxes we can possibly raise.

"Meanwhile, The Economist estimates that the federal government now employs a quarter of a million people to write and enforce regulations."

The more I think about a quarter of a million people writing and enforcing regulations, the more it scares me. Two-hundred and fifty thousand people writing regulations every single day must produce an enormous amount of paper. Perhaps I could give President Obama some help in cutting the federal budget: Why don’t we just fire all of these people tomorrow?

The real solution to the federal budget it getting the federal entitlements under control. It would be simple to make the Social Security system self-balancing and well-funded for the next 100 years. All it requires is someone with the political will to do so.

Medicare and Medicaid are entirely different situations. At the current time, both of these programs are technically bankrupt and will not be anywhere close to self-funding anytime soon. At some point, the government must make the hard decisions when it comes to controlling these costs. Unfortunately, none of the new Healthcare Reform Act does anything to attack the costs of these programs.

I have had several requests for blogs that I will be writing over the next week. One concerns how the TARP will actually repay the amounts expended by the government. Another request concerns the new taxes that will be raised under the Healthcare Reform Act. I have intentionally waited to write that post since it is still unclear as to exactly what tax rates will be in place beginning in 2011. There are fairly significant increases in taxes for people who make more than $200,000 beginning in 2011, and they increase even more dramatically in 2014.

If you have a specific topic you would like for me to discuss, I’ll be more than happy to take a shot at it. As always, the foregoing comments are my opinions, thoughts and personal biases. In all cases, I could be wrong.