Monday, July 25, 2011

Aluminum cans to file class action lawsuit vs. Washington for unrelenting kicking down the road

So another deadline has come and gone in Washington. The lack of leadership in Washington is stunning. Republicans, Democrats, lobbyists, etc all share equally in the blame.

About a month ago I suggested that we would get a "deal" with "huge cuts" that were back-end loaded, no new revenues and a lifting of the debt ceiling past the 2012 election. Well, we're about 2/3rds of the way there as the latest proposal from the Democrats has back-end loaded cuts and no new taxes. However, the reality is the Republicans want to make the debt ceiling a debate every 6 months until the 2012 election so we don't have a deal. The President needs to be careful with his requested debt ceiling hike. If the economy continues to sputter $2-$2.5 trillion might not be enough to get him to the 2012 election (as amazing as that sounds).

One of the major ironies of the markets today is that given the influence of computers in today's trading, we're seeing just a minor dip in the equities while gold rallies and the dollar dips. This lack of panic is not going to force the politicians to make any hard choices and we'll remain in limbo for the foreseeable future. However, we need to be wary of what happens when the computers all head for the exits at the same time (remember the Flash Crash?).

What concerns me is that politicians tend to talk in black and white terms - you're with us or against us, etc. This issue is VERY, VERY difficult to pin down and there are many moving parts.

Let's consider some issues:

1) If we default (or even if we don't) the rating agencies have signaled that they may cut our rating. This is the equivalent of a falling credit score. So now instead of paying 2% on our debt the rest of the world says "We think we'd like 3% or 4% or 5%" on the money we lend you. Higher interest costs wipeout any theoretical "savings" the Federal government might achieve.

2) Austerity measures have consequences. The current forecasts for 2012-2015 US GDP are for 3-4% growth over the next 4 years. However, I saw one forecast this weekend that cut those growth rates to 1%-1.5% for 2012-2015 if certain austerity measures were passed. Again, this is probably a more accurate representation of the non-government growth of the economy but this has ramifications for tax collections (which will fall) and budget deficits (which could grow despite falling expenditures).

3) We can not continue the level of deficit spending that we've enjoyed over the past 30 years. Yes, our deficits have gone parabolic in the past 10 years, but to be honest this began in 80's and we borrowed our way to prosperity. Where do we cut? Well, the easiest items to target those that have seen the greatest increases in the past 10 years. Namely, defense, entitlements, and federal salaries. Again, this would have a huge impact on our economy but deficit spending has artificially boosted our growth rates for 30 years (side note: remember how WE won the cold war? Russia's Debt to GDP - about 7%. US Debt to GDP - closing in on 100%.)

I'll be honest, I never expected this dramedy to go on this long. The global capital markets need to put this issue behind us ASAP. We don't know what will happen if we fail to reach an agreement but I can't picture a scenario that ends well for the US.

Cheers!

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