Gang of 6 Proposal to Save U.S. from Default?

First of all, who the heck are the Gang of 6?

The Gang of 6 are a group of six Senators, three Democrats (Mark Warner, Dick Durbin, Kent Conrad) and three Republicans (Saxy Chambliss, Mike Crapo, Tom Coburn). The six senators banded together earlier this year, and were tasked to try and incorporate the recommendations of the Simpson-Bowies commission (President Obama’s fiscal commission).

After weeks of a standoff between Republicans and Obama’s Democrats, the Gang of 6 emerged with a proposal that might just get both sides to meet half way. Apparently, the proposals will include concessions that could please both Republicans and Democrats. Word is that Obama found the proposals so appealing that he clicked on the “like” button on the Gang of 6’s Facebook page!

The group’s proposals will be centered on tight spending (in other words, austerity measures) as well as some major changes in tax reform law, that will hopefully lead to a trimming of $3.7 TRILLION in deficit cuts over the next 10 years. Here are some of the proposals:

  • Major cuts in discretionary spending. The government will cut spending by $500 billion over the course of the next ten years, with an emphasis on cutting military and defense spending.
  • Spending caps from now until 2015. This is similar to the “Cut, Cap, and Balance” proposal of keeping spending at 18% of GDP. Chances are that the Gang of 6’s proposal will have a little more leeway and will be closer to 25% of GDP.
  • Potential reform in entitlement programs. The proposal could lead to major reform in social programs like Medicare and Medicard, more specifically as to how much should be spent.
  • Overhaul of the current tax code. More specifically, this will focus on the elimination of the Alternative Minimum Tax program and other tax breaks and loopholes in exchange for overall lower tax rates.

If you’ve read my article on the U.S. debt ceiling last week, you’d notice that this proposal strikes a compromise between the Democrats and the Republicans. In other words, the Gang of Six is proposing a tax cut and a tax increase at the same time. Talk about hitting two birds with one stone!

I know what you’re thinking. How in the planking world is that possible?!

Apparently, it’s all just a matter of perspective. On one hand, the proposal would result in a $1 trillion tax increase if you assume that the current policies in place, including the Bush tax cuts that are supposed to expire by the end of 2012, would go on indefinitely.

On the other hand, if you assume that the Bush tax cuts do end in 2012 (and with it, the ATM), the Gang of Six proposal would actually result in a $1.5 trillion tax cut. That’s because this scenario takes into account the fact that most middle-class Americans would be paying the ATM.

I’d rather not get too caught up with all that mumbo jumbo about tax policies though. What’s more important is figuring out how this proposal can impact the U.S. dollar and the forex market.

For now, it seems that debt talks are having a negative effect on the U.S. dollar especially since the August 2 deadline is fast-approaching. It didn’t help that credit rating agency Moody’s recently remarked that raising the U.S. debt ceiling doesn’t guarantee that their precious triple A rating is safe from downgrades.

As I pointed out last week, the USDX is sliding closer and closer to the critical 75.00 mark. Although much of the dollar’s decline can be blamed on the increased prospects of QE3, the looming possibility of a U.S. debt default is also contributing to dollar weakness.

Even though the U.S. government seems to think that defaulting is not an option, it looks like they no longer have any tricks up their sleeve. After all, they already raised the debt ceiling FIVE times in the past decade. But if this Gang of Six proposal pushes through and is enough to keep credit downgrades at bay, the U.S. dollar could recuperate some of its losses over the past weeks.