The Edmond Sun

April 5, 2013

THE ASTUTE INVESTOR: Consequences of sequestration just beginning

Nick Massey
Special to The Sun

EDMOND — A new word has crept into our daily vocabulary: Sequestration. Actually it was originally the verb sequester, meaning “to isolate or hide away someone or something.” But since then we’ve turned it into a noun meaning “a general cut in government spending.” Whether noun or verb, I would bet that a large percentage of the population had never heard the word prior to last year. Never underestimate the ability of Congress to come up with new words to explain their behavior.

So the dreaded “sequester” has gone into effect and we already are dealing with the consequences. If you will remember, the infamous Fiscal Cliff that was in the news last year was a combination of tax hikes and deep across-the-board spending cuts.

Well, the tax issues have been mostly ironed out. Americans will be paying more in taxes, and no one is particularly happy about it. But at least the uncertainty is out of the way, and we know what we’re facing. As the old expression goes — better the devil you know to the devil you don’t know.

Now it’s time for the second half of the cliff, the deep spending cuts collectively called “sequestration.” Judging by the stock market’s recent record-breaking highs, investors don’t appear to be all that worried about the cuts. For all the angst and handwringing we’ve seen over the past year and a half, investors seem to have reached the conclusion that it’s not a big deal.

So what is the story? Is it a big deal?

To start, most Americans agree that the government spends too much money, a lot of which gets wasted. But slicing $1.2 trillion out of the budget sounds like a big cut. That is until you look at the details.  Only $85 billion is scheduled to take effect this year — in a budget of more than $3.5 trillion. Some would argue that barely makes a dent. The rest is spread out over the next 10 years. We’re talking about spending cuts of less than 2.5 percent, and that assumes Congress and the administration don’t weasel out of it. That’s still a real possibility.

If the cuts happen as planned, they probably will take about half a percent off GDP growth this year. And the effects could be worse if they impact business confidence and hiring.

Still, it’s hard to get worked up about spending cuts unless it affects you directly.  Then it is a big deal. Even if the sequester is messy and indiscriminate, it’s better than no cuts at all. The problem, of course, is that one person’s definition of waste or unnecessary spending is someone else’s critical spending. The original idea of sequestration was that across-the-board cuts would be so draconian that Congress would never actually allow it to happen. Instead of a meat cleaver approach to cuts, rational people actually would sit down and make hard decision about what to cut and what to save. So much for that idea.

While we all like the idea of cutting government spending, there are short-term consequences for doing so. In the long run, there are significant benefits. Much like a family cutting its budget to get a handle of their finances, the short-term pain can be worth it for the long-term good.

But what happens when government cuts spending? If you remember your economics 101, the formula for GPD is GDP = G (government spending) + C (private spending) + I (business investments) + E (net exports). You don’t have to be a math major to know that if you cut G, you will have a lower GDP unless one or more of the others increase. So while we all like the idea of less government spending, know that we may well intentionally put ourselves in recession to do it. It’s a little like taking some nasty tasting medicine to get better. Not much fun.

The real issue is not the current sequestration cuts, which don’t matter much in the long run, but entitlements. Social Security and Medicare are already in deficit now when the vast majority of Baby Boomers are still in the workforce and still paying into the system. But what happens after 2020, when those boomers born from 1955-61, the highest birth years, start to reach retirement age?

If you think we have a deficit problem now, take a moment to think about what’s coming.

Actually, I can tell you what’s coming — higher taxes along with lower Social Security and Medicare benefits, particularly if you are considered a “high income” retiree. And believe me, what counts as “high income” is probably much lower than you think.

The bottom line is that we cannot depend on government programs to take care of us in our old age. And this means putting the pieces of a retirement plan together today, while there is still time. Thanks for reading.

NICK MASSEY is a financial adviser and president of Householder Group Financial Advisors in Edmond. Massey can be reached at Securities offered through Securities Service Network Inc., member FINRA/SIPC.