Wrong cliff: US needs jobs, inflation, not tax, spending cuts

"Victory for the middle class is more jobs and higher wages," writes veteran stock-watcher James M. Meyer, of $1 billion-asset Tower Bridge Advisors, West Conshohocken, in a report for clients of Boenning & Scattergood. 

"It couldn't be simpler." But Washington doesn't get it, or doesn't care to do much to make it happen, despite all the talk by President Obama and Vice President Biden and the Republicans in Congress.

Meyer is bracing for "short-term disruption" in stock prices as Congress and the President grapple with boosting taxes and slicing govenrment programs. "But for financial assets that are valued at the present value of long term cash flows, the difference will be inconsequential" once those deals are cut.

He's telling clients not to get lost in the details of the political fight or the initial, probably losing initiatives in Congress. The votes on TARP and the debt ceiling show many members will vote their principles the first time, but make deals for a final compromise.

So there will be a settlement -- probably not a Reagan-style major tax reform -- but at least agreement on tax rates: probably lower for corporations, but with fewer tax breaks. Expect new, higher tax bracket limits, fewer deductions in general, a new estate tax regime. And special breaks important to key Congressmen. 

Still, there's little stomach for more sweeping tax reform."President Obama has never shown an appetite" for such a complicated effort, Meyer writes. "His heart is more into environmental issues, immigration reform and other social agenda items." He does want the rich paying more; he wants a more balanced budget. But when President and Congress are done, he predicts, "there is absolutely nothing that will come out of htis bill that will help the middle class directly."

Budget cuts and tax increases aren't designed to help anyone in particular. To the contrary, "it is quite possible that everyone working and everyone with significant investment income will be paying more taxes next year." And "fewer checks will be handed out." Neither of which help Americans, in the short run.

Where does that leave the middle class? Few Americans are paying any more taxes today than they were ten or 20 years ago. The difference is that there are "about 4 million fewer jobs than there were in 2007." We don't expect to wipe out that deficit until at least 2014 -- but there will be 20 million more Americans than there were before the recession to share the same number of jobs.

The result is the scary and growing income inequality that Democrats use as a stick with which to beat Republicans. "Workers (are) working harder to stay even while corporations have been reaping the benefit, via record profit margins," Meyer concedes. Not because they're "evil," but because they take advantage of supply and demand: Excess labor, the job shortage,  "has allowed businesses to increase wages modestly at a rate insufficient to cover inflation, the rising cost of healthcare, and surging prices for fuel and food."

What's the cure? Two things: "If Washington wants to help the middle class for real, it should do whatever it could to create more jobs and increase inflation," Meyer writes.

Inflation? Federal Reserve boss Ben Bernanke's aggressive mortgage-buying and bank-reserving policy has set us up for future inflation once the economy recovers (as Philadelphia Fed President Charles I. Plosser and other extremists keep complaining). Meyer sees virtue in that: "If wages keep up with inflation, 5 percent growth may somehow feel better than 2 percent growth," and re-flating home prices boost homeowner assets and reduce effective debt. Plus old people whose savings have been stripped by Bernanke's low-rate policy will have some reward for doing the right thing.

So how about job creation? There are plenty of obstacles: Venture investing in new companies is still way down (though buyout and junk bond funds, run by managers who enjoy extensive tax breaks, remain busy); bank loans haven't recovered despite cheap interest rates; the cost of raising money through public share sales have gone up with stricter regulation; the Keystone Pipeline (and many state road projects) haven't been approved (though pipeline delays also mean more money for Warren Buffett's railroads and other alternative fuel transporters).

Congress and the President could reverse those policies. Immigration reform would also help, writes Meyer: by allowing more motivated foreigners to become Americans, since immigrants are more likely to own businesses, and to work, than native-born Americans are.

Republicans claimed to back many of those policies during the late campaign; so did some Democrats. But that's not Washington's priority as the year draws towards its tax-more-spend-less beatdown.

"So when you hear politicians on both sides fighting for the support of the middle class, listen closely and ask yoruself whether what they are asking us to do helps the middle class one iota," Meyer concludes. Sure, we need to get costsunder control and match taxes to spending better." But that won't cure what most ails this country. So "don't declare fiscal discpline as a victory for the middle class."