Tags: Fiscal Cliff | Schwager | inflation | Fed | reform

Author Jack Schwager to Moneynews: Solid Fiscal Reforms a ‘Long-Term Push for Market’

By Forrest Jones and John Bachman   |   Friday, 28 Dec 2012 09:26 AM

Wall Street would greet solid reforms that aim to restore lasting fiscal health in the United States with a long-term applause and react coolly to quick fixes and punts on tough decisions, said Jack Schwager, an author and financial expert specializing in hedge funds.

The White House and Congress are negotiating tax and spending reforms as part of a 2013 fiscal framework. Failure to agree on a game plan will allow sweeping tax breaks to expire at the same time automatic cuts to government spending kick in at year-end, a combination known as a fiscal cliff that could tip the country into a recession next year if left unresolved.

Come to a sound compromise on taxes and make serious reforms to government spending and entitlements and Wall Street will come back cheering, Schwager told Newsmax TV in an exclusive interview.

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“I think if you had something along the lines of Bowles-Simpson and everybody got the message that the U.S. was serious about really solving it and willing to make the difficult decisions on both sides of the fence, yes, I think that would be good. I think that would be a long-term push for the market,” said Schwager.

Editor's Note: Economist Warns: 50% Unemployment, 100% Inflation Possible

He was referring to proposals drafted by the National Commission on Fiscal Responsibility and Reform lead by former Sen. Alan Simpson, R-Wyo., and Erskine Bowles, former chief of staff to Bill Clinton.

Wall Street generally approved of the Simpson- Bowles blend of revenue increases and spending cuts, though President Barack Obama put the recommendations on hold.

On the flipside, Wall Street could roil if policymakers push through a watered-down or toothless plan to narrow deficits and pay down debts.

“If it’s just a patch, if it’s ‘we won’t cut the taxes very much and we won’t ask you to give up much on the entitlements,’ if that’s the solution, that’s not good,” said Schwager, author of the book “Market Sense and Nonsense: How the Markets Really Work.”

Editor’s note: To order 'Market Sense ' at a great price — Click Here Now.

Turning to the Federal Reserve, Schwager commended the U.S. central bank’s loose policies designed to stimulate the economy.

Since the downturn four years ago, the Fed has unleashed a slew of stimulus measures to prop up the economy.

Stimulus tools have included slashing benchmark interest rates to rock-bottom levels to more unorthodox measures such as quantitative easing (QE), under which Fed buys bonds such as Treasurys or mortgage debt held by banks, pumping the financial system full of liquidity in the process to make sure borrowing costs stay low across the economy.

The Fed has been running a third round of QE3 in which it has been buying $40 billion in mortgage-backed securities a month from banks for several months now.

A first and second round of QE injected over $2 trillion into the economy, and the Fed recently said it would beef up QE3 by adding an additional $45 billion in asset purchases from banks, namely U.S. government debt, bringing total liquidity injections to $85 billion a month, with the aim of keeping borrowing costs low to spur investing and hiring.

Editor's Note: Economist Warns: 50% Unemployment, 100% Inflation Possible

Side effects to such policies include rising stock prices, a weaker dollar and mounting inflationary pressures.

The Fed has also said it will keep interest rates low until the unemployment rate drops to 6.5 percent from its current level of 7.7 percent, provided inflation rates don’t climb above 2.5 percent.

Many market participants have feared monetary stimulus tools — QE especially — would pump up inflation rates.

“That’s really not the problem. The problem is not on the monetary side, the problem is on fiscal side,” Schwager said.

“The Fed is making things very liquid but the money isn’t being lent out, so there really is no inflationary impact at this point.”

Eventually, the Fed will have to mop out the liquidity it has injected into the financial system, but for now, stimulus measures are needed until the recovery gains steam.

“Of course the question is can they withdraw the proverbial punch bowl when the time comes, and that remains to be seen, but right now, they probably have been doing the right thing insofar as the situation requires that type of liquidity.”

Pegging low interest rates to a 6.5 percent unemployment rate is a good idea in that it provides clarity.

“You are at least setting a standard for when employment starts picking up, you are going to start pulling back on the liquidity,” Schwager said.

Editor’s note: To order 'Market Sense ' at a great price — Click Here Now.

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