Debt Ceiling Talk, Threats Of Downgrade, QE Or No QE15 July, 2011, 11:15. Posted by Zarathustra
Tags: Barack Obama, Ben Bernanke, Economy, Eric Cantor, Harry Reid, John Boehner, Mitch McConnell, Newt Gingrich, United States
The important thing right now is still about debt. The United States will default on 2 August if debt limit is not raised by then. The politics of that let people wonder: why the US Treasuries are traded at such low interest rates. Indeed, in the CDS market, costs of insuring the default of the United States government have been surging, but yields are still very low, probably because the things in Europe look somewhat scarier.
The gridlock we see in Washington is essentially this: Republicans want to cut spending, and Democrats want to raise revenue, but the Republicans just will not want to see any revenue increases for what ever reasons. Human being is of course very bad at looking at history. As Chris Weigant’s piece brilliantly points out, there was something very similar happening in 1995-1996, when the the then President Bill Clinton, Democrat, fought with the then House speaker Newt Gingrich, Republican (who, by the way, is running for president in 2012). Within the Republicans, there is the leader who held even more extreme position. Guess who he was: John Boehner, Republican. Today, we have Eric Cantor, who is very “childish” and should be kicked out of the talks according to Senate Majority Leader Harry Reid, Democrat. We knew that he provoked the President Obama so that the President lectured him and walked out of the talk, and since then he did not say a thing in the latest meetings, which is, well, good perhaps. The plan B here is the one proposed by Senate Minority Leader Mitch McConnell, Republican, which is gaining some support. The plan essentially allows the debt limit to be raised by US$2.5 trillion in 3 instalments. Each time, the Congress will have to vote to disapprove the increase, but the President can then veto it, meaning that only a third of the Congress is required. This is the deal which appears to be taking shape.
As the political stalemate continues, Moody’s and Standard & Poor’s, who have never been as hard-working as they are now, put the US ratings on watch. Of course, as mentioned in the beginning, the CDS market clearly thinks that the probability of a US default is much higher even though the yields remain very low. As I am controversially bullish on the US dollar as long as the debt ceiling nonsense is cleared, I am not hugely bothered. In fact, Japan survived multiple downgrades and rounds of quantitative easing in the past 10 years or so with even stronger Japanese Yen and even lower bond yields, even though the debt continues counting. One might respond by saying that probably 99% of Japanese debt is owned by Japanese, while the United States’ debts are owned by foreigners. This is a myth, not the truth. As Stan Abrams helpfully points out, that out of US$14.3 trillion of US government debts, only US$4.5 trillion are held by foreigners, of which only US$1.15 trillion are held by the Chinese. The idea that Chinese become the banker of the United States is total nonsense.
For now, as the plan B by Mitch McConnell gains some support, there is hope that it is going to be ok. But any deal here will also mean spending cuts and/or tax increases, which will not be particularly good for the economy in the near-term. The United States is already feeling the effect of austerity, as we have seen the cuts in public sector jobs over the past few months as the Treasury spends less to prolong the debt ceiling deadline as long as possible. That reaffirms my conjecture that the future will be somewhat deflationary. Even though Ben Bernanke reversed by saying that further stimulus is not going to happen for the time being, it will probably happen if the risk of deflationary is back. But again, I am not bothered. The Japanese Yen has got even stronger since they started quantitative easing 10 years or so ago. Who says printing money must lead to depreciation of fiat currency to zero?