The Biggest Risk - And Greatest Reward - For Your Portfolio (Part II)

Alexander Green
by Alexander Green, Chief Investment Strategist

In my last column, I promised to outline the biggest risk and the greatest reward investors face today.

I began with the greatest risk: public sector debt that - when you include current unfunded liabilities for entitlements - comes to $1.3 million per U.S. taxpayer.

The situation is also bad (and often worse) in many of the other leading democracies. Greece - the world's best-known deadbeat - has debt to GDP of 165%. But following close on its heels are Italy (165%), Spain (147% - not the official 91%), Portugal (120%), and Ireland (112%). The United States will soon hit 90% - and that is also the average debt to GDP for the 17 countries in the euro zone. (Great Britain is not far behind at 87%). Of course, Japan stands alone at 220%.

Around the world, politicians have created enormous public-sector benefits without requiring citizens to pay for them. Why? Because this is a winning strategy at the polls. Forget voter rhetoric about limited government and lower taxes. When they vote - which is all that matters - citizens want a generous welfare state (and in the United States a robust military) - and "someone else" to pick up the tab.

This applies to both Democrats and Republicans. Yes, the Democrats have been on an impressive spending spree over the last four years. But conservatives who elected George W. Bush and a republican House and Senate and expected to see limited government, sharp cuts in discretionary spending, a balanced budget, term limits, tax reform, tort reform, immigration reform, and social security reform, got none of these things. What they got instead was the biggest growth in government spending since LBJ. And it wasn't just because of 9/11. We also saw No Child Left Behind, the new Prescription Drug Benefit, record earmarks, and gargantuan new deficits. I'll remind you that the Tea Party originated in protest of George W. Bush and a republican House and Senate that acted just like Democrats, not in reaction to Barack Obama.

I'm not trying to rub salt in the wound, just reminding investors that - despite the sniping on both sides - fiscal irresponsibility is a bipartisan problem.

Americans often complain that Washington needs to stop bickering and get to work solving our problems. The conventional wisdom is that they can't because the two parties are polarized. They want to go in different directions. That's only partially true. The real reason they can't work together is voters won't let them. Politicians know that seriously cutting benefits or raising taxes (on anyone other than the top couple of percent) is suicide at the polls.

In short, Western democracies are fiscally irresponsible because the voters demand it. This was actually the rap against democracy from the beginning, in Athens 2,500 years ago. Critics said it wouldn't work because once the voters realized they could use their elected representatives to loot the treasury, all would be lost.

The concern may have been premature but it's looking prescient today. Politicians don't make tough choices because - despite all the high-flown rhetoric - politics is really about gaining, holding and wielding power. Upset the masses and you can forget about all three. And I'll remind you that despite their chronically low opinion of Congress, voters once again returned 91% of House incumbents to power in the last election.

So instead of solving problems, politicians kick the can down the road, past the next election. Meanwhile, the risk is not just that the public debt is growing. It's that this growth actually hampers and slows the economy. (Ask Spain, whose economy keeps contracting as its debt keeps snowballing.) Furthermore, even those who favor a robust social welfare state should recognize that it can only be funded by a healthy and growing private sector.

In short, out-of-control public sector debt is the greatest threat to our economic future and to your financial well-being. And - while voters prefer to blame their elected officials rather than themselves - the nature of democracy is such that nothing serious is likely to be done about it anytime soon.

What will happen? I'm reminded of the story of a man who went broke who was asked how it occurred. "Very slowly for a long time," he answered. "And then all at once." That's the threat many Western democracies face today.

Yet, despite these facts, there is reason for optimism. Despite the dysfunctional public sector, there are amazingly positive things happening in the private sector - in engineering, electronics, medicine and technology. These pluses actually outweigh the public-sector negatives - for now.

In my next column, I'll explain why this is and how investors - though most don't recognize it - actually face the biggest investment opportunities of their lives today.

Good Investing,

Alex

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