We were all warned loudly by large type headlines and by streams of market commentators, analysts and politicians, including the President of America himself, that if agreement was not reached on lifting the US debt ceiling, the markets would plunge and chaos would ensue. Agreement was reached and the markets plunged. Why? Because the markets, most of the time, are not stupid. Sure, they have their moments, when greed or fear are in full control, at which point nothing in the physical world seems to relate to where market sentiment is headed. But this was not one of those moments. The fact that world stocks hit a two-week low the day after the US finally cobbled together an agreement on the debt ceiling should have surprised no one, and was in fact a perfectly rational response to all that had gone before.
President Obama found exactly the right phrase to describe the problem. “Unfortunately,” he said, “although we have a Triple A credit rating, we don’t have a Triple A political system”. Probably, in the sense that he was reaching for, no democracy worth its salt could even vaguely be described as “Triple A”. Democracy delivers terrible solutions – as Churchill famously said, bad as it is, it remains so much better than all the alternatives. Democracy in the US is storing up huge problems for whatever shade of administration comes into power. The baby boomers are heading for retirement in their millions and the power of the grey vote is going to be huge. Turkeys don’t vote for Christmas, and aged voters do not vote to cut Medicare or to wind back pension benefits. Yet without cutting either, or preferably both of these, the US doesn’t have a prayer of hacking its burgeoning deficit down to size.
Again, the markets know this and have done for some time. It just wasn’t at the forefront of most traders’ minds. Now it is. When a powerful cohort in the Republican Party, aided and abetted by Tea Party members of Congress, decided to take the routine raising of the debt ceiling and turn it into an edge of the cliff political dance, what they did, in effect, was to demonstrate to the world at large that the US political machine does not exactly have a grip on the current situation – said situation being a horrifically large deficit that is getting larger by leaps and bounds with each passing year.
The great Ponzi scheme
Why does this demonstration of political incompetence matter? It matters because, as has been said many times, the US debt is the grandest of all Ponzi schemes. What keeps the funds flowing into America from foreign investors is confidence, pure and simple. The US dollar is the largest pool of liquidity on the planet. However, this does not mean that the US dollar can’t crash. When the debt builds up to a certain, unspecifiable but definite number, the avalanche will start to slide off the mountainside and the result will be ugly. Everyone knows this, but foreign investors in US bonds all make the sensible calculation that actually, either it won’t happen yet, so their latest investment is still solid, or perhaps the US will actually get a grip and see the writing on the wall in time – so, again, their present investment in the latest US bond sale is OK.
However, the spectacle of US politicians playing fast and loose with the prospect of a US debt downgrade is hard to ignore, no matter how much investors want to pretend that the US dollar will be a safe reserve currency forever. That is why the US has really shot itself in the foot with this debt ceiling fandango and why the markets are now in a funk. Quite what will snap the markets out of it, and get them headed back in a growth-facing direction remains to be seen...
Further information on the US deficit, the global financial crisis and the dollar:
- New Dollar Area: The Makings of the Mess by Brian Reading
- Nothing but Painful Choices Ahead as the Global Debt Supercycle Ends by John Mauldin
- Steering Between Deflation and Inflation—A Troubled Road for Developed Economies by Neil Williams
Tags: austerity cuts , austerity measures , Barack Obama , Churchill , democracy , Democrats , dollar , dollar deficit , Medicare , Obama , Ponzi scheme , President Obama , Republicans , Triple A , Triple A credit rating , Triple A political system , US debt , US debt bill , US debt ceiling , US deficit , US dollar , US economy , Wall Street , Winston Churchill