The U.S. debt iceberg still looms

On April 12, 1912, the officer of the deck on the RMS Titanic was slow to react to warnings of an iceberg ahead. But when did react, he did so vigorously, calling for a drastic course change and reversing one engine to help turn the giant ship. It was too little, too late.

Now, just eight months shy of the 100th anniversary of the Titanic disaster, the captain and crew of the U.S. economy — President Barack Obama and Congress, respectively — have made their own belated course correction. After warnings about a giant U.S. national-debt iceberg looming ahead, they reduced speed slightly and announced plans to establish a “super” bipartisan committee to recommend a greater course correction and a change in speed sometime in the future.

These results are the outcome of the compromise debt ceiling bill signed by the president last week. But while Congress and the president acknowledge the enormous iceberg ahead, they couldn’t agree on the degree of urgency of a course change, nor on which direction to move or even if a course change is required, nor if a change of speed is necessary.

So although the debt ceiling bill passed, the national-debt iceberg continues to grow in size, threatening to sink the U.S economy.

The minor spending cuts mandated by the new law won’t halt the growth of the debt while the new committee tries to agree on a course of action. The agreement that led to the passage of the debt ceiling bill failed to address the key drivers of the nation’s mounting debt: mandated spending on Medicare and Social Security.

Even if the committee can agree on course and speed changes, including changes to these programs, the iceberg will continue to loom ahead and grow, because Congress is unlikely to go along, despite threats of painful automatic cuts that will be triggered by a failure to agree.

Likewise, if the committee should agree on ways to increase federal tax revenue, there is no certainty that the proposals will be accepted in the Republican-dominated House of Representatives.

DECISIVE WIN

Failing an unlikely agreement by Congress to take bold action on both long-term spending and the need for additional federal revenue after the committee reports, a decisive election win by either party in November 2012 is the best hope for avoiding the iceberg.

In the meantime, financial planners, investment advisers and their clients have to struggle along, making decisions in an environment of unusual political and economic uncertainty.

So far, advisers and investors must wonder if anyone in the White House, Congress or the Federal Reserve knows what he or she is doing.

The government’s fiscal-stimulus efforts have produced little economic gain, while boosting the federal deficit. The Federal Reserve’s two quantitative-easing efforts have produced little but higher commodities prices and rock-bottom interest rates, which have punished savers and retirees living off savings.

Advisers must fear a second round of recession in the short run, followed by a burst of inflation in the long run as the government chooses to turn on the printing press to pay down its enormous debt — a trick resorted to by profligate governments all too often in the past.

Clearly, this isn’t an environment conducive to making long-term bets on the future. Advisers and investors no doubt will be tempted to keep strategies conservative and short-term-oriented.

The rush of money into Treasuries, especially short-term Treasuries, in the wake of the debt ceiling agreement demonstrates that many already have adopted a “think short” outlook.

Unfortunately, a focus on the short term likely will further weaken and slow the recovery at a time when strong economic growth would make the debt-cutting responsibility of the new congressional “super” committee much easier.