Washington DC has become a Significant Risk to Investors’ Portfolios

By: David_Urban

S&P’s warning on the US credit rating and the subsequent refusal to acknowledge the problem should give investors pause.

The inability to tackle the budget deficit and debt problem is causing the Dollar to selloff and head towards levels not seen since late 2009.

The US government continues to follow the thesis posited in my 2011 commentary. Instead of cutting spending, both parties in Congress are fighting to see how little they can cut. 

As the debt ceiling deadline approaches, Republicans are being backed into a corner with media outlets calling for doom if the debt ceiling is not lifted and constituents screaming for spending cuts.

The recent FOMC statement highlights the problems coming out of Washington DC as Federal Reserve governors Charles Plosser and Richard Fisher made the following comments in recent speeches:

Richard Fisher’s comments from a speech on April 8th, 2011: http://www.dallasfed.org/news/speeches/fisher/2011/fs110408.cfm

Personally, I felt the liquidity needed to propel our economy forward was sufficient even before the FOMC opted last November to buy $600 billion in additional Treasuries on top of the committee’s pledge to replace the runoff of our $1.25 trillion mortgage-backed securities portfolio. I argued as much at the FOMC table. I considered the risk of deflation and of a double-dip recession to have receded into the rearview mirror.

Charles Plosser’s comments from a speech in Harrisburg, PA on April 1, 2011: http://www.philadelphiafed.org/publications/speeches/plosser/2011/04-01-11_harrisburg-regional-chamber.cfm

Some fear that the strong rise in commodity and energy prices will lead to a more general sustained inflation. Yet, at the end of the day, such price shocks don’t create sustained inflation, monetary policy does. If we look back to the lessons of the 1970s, we see that it is not the price of oil that caused the Great Inflation, but a monetary policy stance that was too accommodative. In an attempt to cushion the economy from the effects of higher oil prices, accommodative policy allowed the large increase in oil prices to be passed along in the form of general increases in prices, or greater inflation. As people and firms lost confidence that the central bank would keep inflation low, they began to expect higher inflation and those expectations influenced their decisions, making it that much harder to reverse the rise. Thus, it was accommodative monetary policy in response to high oil prices that caused the rise in general inflation, not the high oil prices per se. As much as we may wish it to be so, easing monetary policy cannot eliminate the real adjustments that businesses and households must make in the face of rising oil or commodity prices. These are lessons that we cannot forget.

Yet when it came time they voted to continue the same policies they spoke out against exposing them as doves rather than hawks.  In contrast, Thomas Hoenig who spoke out against accommodative monetary policy not just in speeches but in FOMC statements as well.

We have the Democrats spending like drunken sailors, the Republicans paying lip service to the reason they were elected to Congress, and a Federal Reserve that cannot define how inflation is created. 

At this time one should be reducing the leverage in their portfolios until the investment landscape becomes clear.

By David Urban

http://dcurb.wordpress.com/

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