It is appropriate during this season of growth, known as Spring, for the US and world economies to be showing continued signs of vigor.  News of Osama bin Laden’s death at the hands of US forces comes on the heels of protests and in some cases, regime changes, in the Middle East and North Africa.  No matter what you think of the death of Osama bin Laden, the effect on the US, much less the world economy, is negligible.  What is the outlook for the US as we proceed through the second quarter and what factors will come into play?  We lay out our thoughts below:

Unemployment is continuing at a pace in excess of 8% and the US economy continues to feel as if it has problems, but the leading US indices are positive year-to-date, with the S&P Index up 9% the Dow Jones average up 12%, and the NASDAQ up 9%.  Even more surprising, the US equity markets are leading the world markets.  TheMSCI World Index is up 8%, with Chinese markets showing positive growth, and Brazil showing more sluggish growth.  Although their economies as measured by gross domestic product (GDP) are growing, the equity markets in Chile and India, two of the developing world’s economic rising stars, have shown negative returns for the year.

The US forces’ success at tracking down Osama bin Laden may serve to lower oil prices and strengthen the dollar in the short term, but many factors will contribute to cause oil prices to rise and the dollar to continue its fall over the long term.  The boost to morale within the US may be the most positive and long-lasting effect for our economy.  Since by almost every measure the US economy is growing, the added morale boost may be just the added push the consumer needs to accelerate the pace of growth.  In the meantime, oil prices are most related to supply and demand.  As the unrest in the Mideast grows, the threat to supply has pushed oil prices up better than 50%.  The result is that gasoline prices in the US are certain to reach and exceed $4.00 per gallon by Memorial Day.  The growing demand from developing countries such as China, India and Indonesia, just to name a few, is what is pushing oil prices higher.  The continued US government’s deficit spending is what is depreciating the value of the dollar.  So, unless something changes to either reduce demand for petroleum or significantly alter the US government’s spending or revenue collections, high gasoline prices are here to stay.

The outlook for the US beyond this quarter is pretty much tied to what is occurring in Washington these days.  The US economy in terms ofGDP is measured at about $15 trillion according to the US Department of Labor Statistics.  Expenditures by the Federal government for 2011 are estimated at about $3.2 trillion per the Congressional Budget Office.  Those expenditures represent about 21% of all economic activity in the United States, so their effect is significant.  This amount is up by about half a trillion dollars since 2007,  so decisions made by the federal government significantly affect the economy.

The current political climate is one of partisan bickering.  With the Democrats controlling the White House and Senate while the Republicans control the House, we face political gridlock.   With interest rates hovering around all-time lows and tax rates on individuals close to all-time lows, there are benefits and detriments to the political gridlock.  Since interest rates are unusually low at this time, businesses have access to capital to invest at much lower costs than usual.  This phenomenon is due to a strengthened economy and low taxes, in conjunction with a government policy of low interest rates.  As discussed in earlier reports, the result of such low capital costs is that businesses are spending on equipment rather than hiring.  This is an unintended consequence of the Federal Reserve policy of low interest rates and has led to a “jobless recovery”.  In addition to the unemployed, seniors are harmed by such low interest rates because fixed income is the replacement for most seniors for wages once they are retired.

The structural issues within the US economy (spending more than tax receipts) will continue to make the US less attractive to investors and could lead to two undesirable scenarios.  First, this imbalance could mean that that eventually the US will be forced to borrow at much higher interest rates.  Second, high spending and low interest rates cheapen the dollar and the relatively high cost of oil and other commodities could push the US economy into a recession.  The solution is simple but politically scary: raise taxes and cut spending.  Currently, taxes are at a historic low while government spending as a percentage of the economy has never been higher except during World War II (and it is growing!).  Social Security, Medicare and Medicaid account for a little more than 40% of government spending, and would be logical albeit painful to reform.  Military spending accounts for almost another 25% and with two wars raging, it is not easy to cut spending there either, and yet spending cuts are vital to our survival as a growing society.

So, how will all this doom and gloom affect you?  It is virtually certain that tax increases are in our future and that benefits for Social Security, Medicare and Medicaid will be reduced.  The taxes on the top 5% of wage earners who contribute more than 50% of the tax revenues in the US are an easy target to raise in order to start balancing the budget.  The next group to pay more is the group earning about $94,000 and up.  After that, we can expect no changes for the current retirees and the older half of the baby boomers.  The rest of society, from the younger half of baby boomers and down should expect to work longer and receive fewer benefits from Social Security and Medicare.

We are stating what we believe will occur so you can take advantage of the present situation and prepare for the changes ahead.  We plan to work with you, our clients, in preparation for these inevitable changes.  Although a tax increase combined with Social Security and Medicare cuts would be painful, it would prevent the US from following Greece’s or Iceland’s example of being forced to deal with their debt issues by having our debt rated as junk.  The current deliberations and painful choices will hopefully allow our political representatives to better balance our current needs and expenditures with our ability to afford them and leave the country in a better position for the next several generations.  There is poetic irony that this situation is coming to a head now in the midst of Spring, a time known for renewal.  We hope that this time it will bode well for the US as well as the world.  We have a chance with the coming together of our society by the death of Osama bin Laden to right some wrongs and imbalances which, if our leaders act as statesmen rather than politicians, can lead the US to a peaceful and prosperous future.