In 1979, the US Treasury failed to redeem 122M in Treasury bills. At the time, they blamed technical errors with a word processor and a delay in approving an increase in the debt ceiling. But as soon as those issues were addressed the money was repaid along with a penalty, and world continued to spin.
The world didn't end in 1979. Borrowing became horribly expensive for the government and the price of hard assets skyrocketed. We had to invent a new term for the failure of keynesianism - the hence overused term 'stagflation'. But in the fullness of time we elected an administration that actually understood something about how the economy works, and all the issues were resolved.
If we have a technical default, we will survive it. Even if Obama decides to keep the money flowing to his union handlers instead of paying the debt, turning our technical default into an actual default, we will still survive it. Countries have defaulted before. And although standards of living fall, and maybe government are overturned... life goes on.
So the good news is, even if everything he does turns out to be the exact wrong thing to do, Barak Obama does not have to worry about destroying the United states in that way. It won't happen. We'll continue to see the completion of Jimmy Carter's second term, with anemic economic growth, skyrocketing prices of hard assets, a lowering of the standard of living, and a general economic malaise. But the world will not end that way.
But if Obama decides to issue debt in defiance of the 14th amendment, then all bets are off.
Most Americans don't seem to realize that inflation and hyperinflation are two very different things. Inflation is a mistake. Mistakes happen, and when they do, they can usually be corrected by the person who made them (or at worst - the person who replaces him). In almost all cases, inflation is a relatively mild and short lived phenomenon. And when it's recognized by policymakers, it can be dealt with very effectively by increasing interest rates.
But hyper-inflation is not caused that way. Hyper-inflation is caused when the markets lose confidence in the ability of a political body to act rationally. When political decision makers let politics trump every decision, be it rational or not, then hyper-inflation is often the result. Printing money is easy, and virtually costless to the people who do it. And when politicians let it become a solution to problems that should be solved in other ways, a run on the currency is often the result.
It's literally the difference between being wrong, and acting crazy. If Obama issues new debt without getting the debt ceiling raised, then it will be an announcement to the markets that the US is no longer respecting the rule of law. It will be an economically irrational act, driven by politics. And if that's so, then what's next? Downgrade or no downgrade, the result will be a run on US Treasuries and radical rise in interest rates. If that happens, the Fed will likely step in as a buyer of last resort and the run will move from US Treasuries to the US Dollar.
At best the result will be a dramatic drop off in economic activity and a fall in the prices for all risky assets. America can be impoverished in an instant.
Obama cannot destroy America by being wrong. Neither can Tim Geithner, or Ben Bernanke. No one can. Jimmy Carter was wrong about everything, and he didn't manage it. But if Obama abandons the rule of law, it will shake the markets at their foundations. At that point, America really will have become a banana republic and it will be Barak Obama who finally made it into one.
9 comments:
Have been looking forward to your thoughts on the last few days.
Thoughts/questions:
1.) Got gold?
2.) Do you think McConnell provided the out BO needed to not unilaterally defy the 14th?
3.) And if yes to #2, does he take it?
4.) Can that get through the House or Senate?
5.) Why the hell did McConnell provide the out? On July 12? As mentioned here previously, I have learned to never underestimate how well Rs can snatch defeat from jaws of victory.
6.) Where do you make the current market on Wrong vs. Crazy?
I started to really worry about this about two months ago. The way this appears to be unfolding has not eased my worries.
A hard ideologue holds the White House. His party is not the party of the Carter era. Those Democrats, like Scoop Jackson and Hubert Humphrey, held to pragmatism because they honored and respected the truth.
Today, as we can see through through the position that Pelosi has now taken, the legislative majority party are "believers," without the intelligence of Carter era legislators. The truth matters less than their goals, for the present day crowd. It is less taxing intellectually to be that way. You also do not need to cnsider the complexity of 3,000 word bills and hunreds of thousands of regulations that hang in the balance.
The left "believers" that now hold power in Washington negotiate like terrorists - you make a reasonable proposal, like the Ryan Plan, and their response is "Death to America." What is your response to that - how about we put the time of death back a little while, so we can talk about some other part of this?
In the past, the Rupublicans took what the could to minimize the damage and got out. The legislative class of 2010 ran against this get along way, which is uniquely ill suited to negotiations with the "Death to America" crowd. The 2010 class collectively know they were sent to do a job. They too are believers. Right now, every talking head economist I have heard, like Bruce Bartlett yesterday on Bloomberg, are focusing their efforts on the class of 2010. That McConnel has cracked is no surprise. The questions is whether enough of the class of 2010 will "fall in line."
I have theorized that Stalin, who was from Georgia, took some of the all encompassing elements of Islam and grafted them onto Communism. He left behind the patience in implementing Sharia in a new land that Islam teaches. This same kind of patience was intuitive for Carter era leftists. But Stalin as a "believer," to whom short term pain did not matter. Both Communism and Islam have long term plans. I think the class of 2010 knows well what negotiating with a believer yields. The more the Democrats act like believers, the fewer of the class of 2010 will crack.
I think August 2 will come and go without a deal. I have not scoured the news, but I am looking for signals like more resignations of economic advisors.
In other news...
Bernanke hinting at more "Stimulus". Looks like QE3 is getting ready to sail!
Wow ... you take a little time to repair something in the backyard and look what happens.....
1. I Got it... I also got silver. In the case of gold I bought in at 762.
2. I hate to handicap raw politics. I get McConnell's plan, but I don't know whether it's in the long term interest to make all of this an issue for the voters to settle. After the last presidential election, I have serious doubts about the voter's wisdom.
3. I'm hearing it's all a non starter anyway.
4. See 3.
5. See 4.
6. Good question. I'm always hesitant to attribute to malice what can be adequately explained by stupidity. And I think it's clear that Obama is an economic illiterate who thinks government adds to fairness instead of actually diminishing it. So stupid and wrong is the way I would lean. But he is a product of that academic mindset that while they usually deny it, they actually hate America and American values because it does not place them at the pinnacle of the social structure, where they believe they belong.
And because that’s so… because I honestly believe that he hates what you and I would call classic American values, I think it's entirely possible that he will blow the whole thing up. The markets don't agree with me at the moment. But we'll see what happens in the next few weeks.
But I’ll say this again…betting against the big singularly defining moment is ALWAYS the way to bet. The bomb almost never goes off.
But like Frithguild says… so long as their position is “Death To America” how do you meet them halfway on something like that? Can we put off the time of death a little to have a chat?
Class of 2010 "Believer": "As many as 100 Republicans would not vote for a negotiated debt ceiling increase if it does not include significant cuts in the first year, according to Rep. Tim Huelskamp (R-Kan.). The freshman lawmaker said he and other freshmen members see a once-in-a-lifetime opportunity to curb uncontrolled spending."
So does the market, which doesn't see a blowup, see Republicans who bid against themselves all the time, or believers like Huelskamp, when it tells us that a deal will be struck?
Honestly Rob, I couldn't tell you. A present I think they're WAY under-bidding the odds of a blowup. But let me offer this as perspective:
I have a good friend who is head of Fixed Income trading at a large international investment bank. I have another who is a legend in the energy trading business, and used to run the commodities trading unit of one of the big 5 investment banks.
My buddy the commodity guy thinks it’s all going pear shaped. He thinks we’ll default, the euro will break up, the Chinese economy will collapse, and murder and mayhem will rule the earth. Well, that’s overstating a little, but he really does believe that in the next few years there will be nothing left of America.
My buddy the fixed income guy believes that this will all get worked out, and we’ll have a Japanese decade of zero growth, and modest deflation. He thinks it will eventually be resolved by demographics and a higher savings rate, but that our living standard will fall throughout. He doesn’t see this debate as an issue because he thinks that sooner or later someone in Washington will sell out their constituency to save their neck. I’m sure you’ll agree that history is on his side on that particular score.
Me …I’m somewhere in the middle.
I recognize that the odds of either of those scenarios is big enough to worry about, but apart from that, I tend to bet on things muddling along rather than blowing up. So I think my buddy the fixed income guy is probably closer to correct (meaning the odds of it going that way are bigger than 50% or this particular debate), but when I hear the talk I think the odds are closer than anyone imagines.
&&&& UPDATE &&&&
I just got off the phone with a friend and former colleague of mine - another PM at a major hedge fund who is now running his own small firm. The call was about other things but afterward came the following:
Me: "So what do you think... will we have a default?"
Him: "...sigh ... I really hate all the political wrangling, but yeah... I think we do. I think they'll default. I don't think you're getting all those people to agree on anything until they see some ugly."
Truer words....
Hey Tom. I want this to be explicit - my questions or comments here are not intended to wheedle out information held in confidence. I know the importance of keeping a confidence.
My rhetorical flourish here was questioning whether the market understands or will be surpirsed by the collective behavior of the class of 2010. If the market tells us now there will be a deal, then I question the collective wisdom of "the herd."
Right now the news it is quiet. A deal is probably in the works. But the class of 2010 has been so pilloried, I am guessing they are not in the loop. If they are not part of reaching a deal now, which is probably a 3,000 word processing enabled curse already drafed like QE1, they will let August 2 pass. Something will be done shortly after to cure the default, because everybody loves a savior. No pear shapes. Just my SWAG.
Frithguild, don't sweat it. I'm perfectly aware that even though this is conversation between two guys who know one another, it is not a private conversation. I would never betray any confidential info here.
Post a Comment