Congress Punts, Stocks Slammed

11/21/2011 10:47 am EST

Focus: MARKETS

Igor Greenwald

Chief Investment Strategist, MLP Profits

The failure to reach a budget deal is a costly reminder that the Fed remains our only willing rescuer, writes MoneyShow.com senior editor Igor Greenwald.

A funereal gloom has descended on the markets this morning, after the congressional supercommittee confessed an inability to compromise even on the modest budget cuts that were its goal.

Worrying about the long-term US budget deficit might actually pass for a sign of dangerous optimism, as Europe self-destructs and the Middle East’s short fuse burns. And indeed, the bond market is convinced that fiscal laxity is the least of its problems.

As argued here Friday, failure to strike a budget deal punts the pigskin into 2012, but hardly ends the ballgame. Many of us will know the new year has arrived when paychecks shrink a little, as the 2009 payroll tax cut expires alongside other income props.

Others have pointed out that a deal might not materialize next year either, if either side believes it will have more leverage after the election.

Though the sums in dispute are trillions, their relative scale is modest: the $1.2 trillion in cuts sought by the supercommittee is less than 0.8% of our likely economic output over the coming decade.

And that’s part of the problem: If the two parties can’t even work out a token savings program, their chances of effectively resolving the economic difficulties facing this divided government look slight. “Fiscal policy actions that reduce uncertainty and stimulate recovery are badly needed,” San Francisco Federal Reserve President John Williams said in a speech Friday.

And whether you agree or feel the opposite, the reality this morning is more of the same, except that taxes will be going up. This degree of political dysfunction, while not quite rising to Europe’s gold standard, is what has institutions buying Treasuries, the most liquid asset class. Even the dollar is benefiting.

For stocks right now, political dysfunction is pure poison. The old nostrum that political gridlock is good for Wall Street is a relic of earlier, happier times.

Corporate profits are hugely sensitive to relatively modest swings in economic growth. Right now, no government on Earth seems capable of moderating these swings, and indeed current European policy is proving hugely destabilizing.

As Europe tips into a certain recession, US fiscal policy has officially been sidelined. That leaves us with the Fed as the last resort. And that suggests that the dip in gold is the only one worth buying.

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