(1/20/2001)- The stock market has gone through some very turbulent months since it's high of 11,722 set the week of January 14, 2000. The Dow Jones Industrial Average closed at 10,588 on January 19, 2001. We must ask ourselves what is causing this decline? Has the decline ended? Please keep in mind that before this year the only correction of over 10 % to have taken place in the Dow Jones Industrial Average was in 1998 when due to fear of the financial collapse set off in Thailand and in Russia. No corrections of 10 % or more took place in the Dow Jones Industrial Average from 1991-1997. The Fed's Open Market Committee cut interest rates by 50 basis points both for the federal funds rate and the discount rate early in January 2001. Most experts are predicting that they will lower the rates at their next meeting on January 30-31, 2001, since their "bias" has now shifted to lower away from higher.

Former President Bill Clinton has increased his 10-year estimate of the budget surplus from $2.9 billion to $5 billion. President Bush estimates that the surplus is almost $6 billion. In spite of all the rhetoric by both the Democrats and Republicans absolutely nothing has been done to reform either Medicare or Social Security. As we have expressed several times what worries us is that if nothing has been done to reform either Medicare or Social Security in the "good times", what will happen once the budget surplus estimates are cut or even move back over to the deficit side? Surely the estimated life solvency of these 2 critical social programs will begin to see reductions. Will we then have to have borrowing to balance the budget come from the Medicare and Social Security Trust Funds thus weakening them even further?

The Federal Reserve Board's Open Policy Committee had voted to increase rates at it's meeting held May 16th, 2000.That was the 6th increase in interest rates in less than a year. Well the economy is now showing signs of cooling down. The Fed's Open Policy Committee voted to cut interest rates early in January 2001. Both the Fed Funds rate and the discount rate were decreased by 50 basis points to 6 % and 5 1/2% respectively. The key interest rates are now the 2-year, 5-year and 10-year Treasury issues. Please keep in mind that the 30-year bond is no longer considered the key interest rate guide. The government has bought back $16 billion of 30-year bonds already this year, and its current plan's call for the purchase of a total of at least $32 billion of the 30-year bonds. There are $576.3 billion of 30-year bonds now outstanding versus $544.5 of 10-year bonds outstanding. The Treasury has also announced a new policy regarding caps on the percentage it will buy of any specific new issue. The new caps are as follows: 35 % for 1-year, 6-month and 3-month bills; 25 % for 2-year notes; 20 % for 5-year notes; and 15 % for 10-yearnotes and 30-year bonds.

To help our viewer's keep track of where interest rates are we will institute a chart to help you in this area:

Thus since our posting of June 9, 2000 interest rates have gone down about 186 basis points for the 2-year maturity and about 159 basis points for the 5-year maturity and 99 basis points for the 10-year maturity. With interest rates receding somewhat the Dow Industrial Average closed on January 19, 2001 at 10,588. It is now about 7 months since interest rates have been declining.

The Clinton administration has estimated that the government will be able to reduce the national debt by a record $185 billion in the quarter ended September 30, 2000. The administration has estimated that the budget surplus for the year 2000 will be $168 billion, while the CBO recently put the estimate at over $200 billion. It is estimated that the government will have reduced publicly held debt by $216 billion during the fiscal year that ends in September, and by $350 billion since fiscal year 1998.

It is our contention that the higher interest rate problem first came into the forefront in July of 1999. That is when higher interest rates began to appear and talk of abandoning the caps imposed by the BBA of 1997 arose in earnest. Now as the projections of the budget surplus continue to grow all political sides of the spectrum talk of abandonment of the caps and how to spend the surplus. Former President Clinton in his last budget address spoke about lifting some of the "spending caps". Remember that the stock market has helped to create the surplus, and if it heads in the other direction it could ultimately result in the surplus evaporating.

Some of you may point to the fact that the long term 30-year Treasury bond has declined from almost 6.75 % to about 5.5 % recently. This decline however has been caused by the "reverse repos" that we discuss herein and the decline in supply of 30-year bonds being issued by the Treasury Department.

When we first wrote this article in July of 1999 we contended that the main items that were helping create the balanced budget, which has now turned into the growing surpluses, were the combination of the Balanced Budget Act of 1997 and the bullish stock market. The Dow Jones Industrial Average in closing at the 10,738 level on January 28th, 2000 is at just about the same level it was in July of 1999. It is only slightly lower than that level as of the January 19th, 2001.

The Act set up governmental spending limitations that could not be exceeded unless offsetting cuts were made in another area. The only way an exception could be made was if there was need for "emergency spending". The law required that emergency spending must be for " unforeseen, unpredictable and unanticipated needs".

Lately the news media has highlighted the fact that the CBO is now predicting close to a $5 trillion surplus over the next 10 years. The politicians and the president are loudly proclaiming their own plans as to how they would spend this surplus. They further state that there is no need to adhere to the "spending caps" set up under the BBA of 1997. We believe however that the stock market is warning us that this approach to "spending the surplus" is the wrong approach. Those who call for a cut in taxes to benefit the taxpayers are also taking a wrong approach. This approach is wrong because it would mean that the federal government would have less income to deal with its problems. If the stock market went into an extensive decline all the predictions of surplus would go out the window. We pointed out in July 1999 that interest rates were starting to rise. Please keep in mind that the majority of stocks went down in 2000, not up. Just because NASDQ soared in 1999 does not mean that all stocks soared in 1999. Conversely just because the NASDQ stocks have plunged in 2000 does not mean that the stock market has collapsed in 2000.

One of the prime beneficiaries of lower interest rates is the U.S. government, since it is the largest borrower in the world. If rates stay low the U.S. government can save billions of dollars. As our article will go on to explain the Balanced Budget Act of 1997 has been the key element along with our healthy economy in bringing the budget into balance. If however the economy falters and therefore revenues decline, we could be in for a great deal of difficulty. Furthermore, the failure of Congress and the President to pass the budget on time (September 30, 2000) is another example of unnecessary waste in government. In our home State of New York, failure to pass budgets on time is regarded as so routine that many of us no longer even get upset about this added cost that the taxpayer has to bear.

The headlines in many newspapers recently proclaimed that there actually was a slight budget surplus in the fiscal year of 1999, even when Social Security moneys were excluded. This occurred because there was a greater revenue growth than had been previously estimated. The problem with this headline is that it took a lot of financial juggling of the books to make it appear as if there truly was a surplus. It looks like Congress will spend about $23 billion in the fiscal year 2000 budget that it will call "emergency spending", and thus circumvent the "spending caps" imposed by the Balanced Budget Act of 1997.

Remember that it was only 2 years ago when it was predicted that Medicare would go insolvent in 2001 and Social Security would go insolvent in 2029. Because of the healthy economy the last 2 years the predictions have now been extended to the years 2025 and 2034 respectively. Incidentally, a panel of health experts recently found recommended to the trustees of the Medicare Hospital Trust Fund that 2021 was a more realistic estimation for the life of the solvency for that fund. If the economy weakens and revenues come in less than expected will we than have to cut back on the expected time frame for solvency for these programs?

We can now look back and ask ourselves what might be a logical reason for this Dow Jones standoff since last year. Is it because of the strong yen? We doubt it because many of us remember that the market as reflected by all its commonly used indexes rose in the early 90s as the yen reached its all time high as against the dollar. Is it because of our record trade balance deficit? We doubt it because we have been running a trade deficit for so long now, and yet the stock market has risen throughout this period. Is it because the Euro has recovered to being above the 90 cent level compared to the dollar? We doubt that this is the core of the problem.

Our thesis is that the prosperity that has existed since 1997 has as its main thrust the Balanced Budget Act of 1997. The "spending caps" imposed under this act has been the main reason for the reduction in deficit on a Federal level, and in turn this has caused a lowering of interest rates. Inflation has remained under control. Now however, Congress through some illusory accounting is attempting to circumvent these caps. In arriving at a final resolution to the fiscal year 2000 budget crisis, the Congress and the President agreed to an across the board slightly less than 1 % cut in each area. Incidentally, the defense area is the only area in which increased spending was called for in the fiscal year 2000 budget. Republicans are calling for tax cuts in light of the budget surpluses. Democrats are calling for spending increases above and beyond the "spending caps". If the stock market continues to decline and if we have less and less surplus to deal with there will be no chance whatsoever for Medicare and Social Security reform. The solvency issue will hit us smack in the face only we may be at crisis level when that becomes obvious to some of our politicians.

We would like to state that we are not predicting the direction of the stock market in this article. Experience has shown us that the stock and bond markets will act as a posse to try and redirect us when we head the economy in the wrong direction. If we don't listen to what it is saying it will mean trouble for the economy.

We are especially concerned in this matter, because it is most likely that Social Security funds will once again have to be utilized in order to be able to stay within the parameters of the "spending caps" imposed by the Balanced Budget Act of 1997. Even though the CBO is now estimating close to a $5 trillion budget surplus in the next 10 years, at the same time they are estimating a $2.3 trillion Social Security deficit in the next 20 years.

In the days of the old wild west a posse was often needed to help the legal authorities reign in the bad guys. The fear of having a posse descend on them was enough to keep the bad guys away from some areas. We are saying that the stock market is acting like a posse in telling our president and elected officials and Fed Chairman Alan Greenspan that they better be careful, or else they are courting trouble.

Since the spending caps are imposing tough limitations on spending Congress is thinking about calling some ordinary expenses "emergency expenses" and thereby trying to circumvent the true meaning of the Act. Anybody who has a family budget understands that oftentimes-tough choices have to be made and adhered to.

As we pointed out in our article "What Trillion Dollar Surplus are They Dreaming About" there is no trillion dollar surplus. We have also pointed out that the expected life solvency of both Medicare and Social Security has been increased immeasurably in the last two years because of a healthy economy. If the economy turns sour the reverse will occur and the estimations will have to be cut as to the expected life solvency of these programs.

We have stated in some of our prior articles that we favor Medicare coverage of prescription drugs. We realize that this would mean increased expenditures for the Federal government. We think that if the proper plan is passed the increase in cost could be held to reasonable levels. Compromise would have to come from some other social programs because we realize that it can not come from just the defense spending area. Congressmen will have to also realize that pork-barrel legislation will not be tolerated. This may sound naive but it can be done especially when it is for the good of all of us.

This article does not in any shape, manner or form attempt to predict the future direction of the stock market. It is stating that the stock market is throwing off a warning signal, and depending on how we react to this signal, will determine the future direction of the stock market.

FOR AN INFORMATIVE AND PERSONAL ARTICLE ON PRACTICAL SUGGESTIONS WHEN SELECTING A NURSING HOME SEE OUR ARTICLE
" Selecting a Nursing Home"

By Allan Rubin
Updated January 20, 2001

http://www.therubins.com

To e-mail: hrubin12@nyc.rr.com or rubin@brainlink.com

Return to Home