US Debt debate – more political unrest for markets

July 25, 2011

Global Macro

This morning markets have kicked off with the bad news that after talks broke down late friday in New York that there still seems to be a gulf between the Republicans and the White House on resolving the impasse to lift the debt ceiling before the deadline of August 2nd. Already the twitterverse, at least the commentators I watch and respect, are saying get the pop corn ready as this is going to be interesting.

Markets like boring, at least most market participants do,  so that investors and traders can make informed decisions about the investments and trades they are looking at making. So the bad thing about interesting is that it increases uncertainty and as we have seen in Europe over the past few months uncertainty is poison to markets.   

Now everyone seems to continue to signal that Europe is still the big issue and the US will get the job done on raising the debt ceiling. Whether it does or doesn’t this time around isn’t really the issue though as the sea of debt that burdens the developed world is all-pervasive at the moment and ensures lower growth rates over the coming few years, probably decade. For Australians this is an important side show but side show it is because we are tapped into the new global engine of growth, Chindia.

But we still cannot avoid the fact that the Eurozone is struggling, at least at the periphery, with huge debts and the United States, which has kicked the Sovereign version of an own goal with its Debt debate, is likewise bothered by the absolute value of its debts.

Austerity is a term that we will need to become comfortable with because austerity is now a political must for peripheral Europeans who need to be bailed out by the less profligate members of the Eurozone and austerity is now going to become  “du rigor” for the United States. This is because the Tea Party is taking the Republicans so far to the outer edges of the “no new taxes” protocol that even a cut in entitlements is deemed to be unconscionable by Republicans.

So it was really no surprise that talks broke down over the weekend between the Republicans and the Democratic Whitehouse. With the seeming resolution in Europe, or at least the appearance of a plan that might work for a while the talk on Thursday night our time was all about moving toward a resolution also in the US and on Friday, New York time, the New York Times actually tweeted that a resolution had been made and that the debt ceiling had been raised. But alas it was not to be the case and Reuters reported Sunday that “New disagreement erupted late on Saturday between congressional Democrats and Republicans over the timetable for increasing U.S. borrowing authority, possibly jeopardizing efforts to avert a default.” My bolding but this is an unfortunate new turn for financial markets.

I confess to having felt, and still hope, that US politicians would not repeat the mistake they made in Sep 2008 when they failed to pass TARP and markets melted down. But I am less certain now than ever.

Markets are as well, it is early Asian trade so we are always wary but Dow futures have opened down 117 points and gold has shot up 1.3% to $1621 as I write. There seems to be a genuine gap between the protagonists in this play and we’ll see how this evolves over the next week. I still hold that they’ll get their act together and cobble together some sort of solution.

But at the end of the day the debate is about increasing the debt ceiling which means allowing Uncle Sam to borrow more so it can pay its debts. Now in anyone’s language, that’s a recipe for disaster.

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