2011 July – Comments on the Debt Ceiling

On July 26th, 2011, posted in: Economic News, Newsletter by

Contrary to popular belief, many money managers are saying the “debt ceiling” has turned into the investor’s best friend. Professional politicians don’t like it, because they don’t want to limit their degrees of freedom. But the “limit” on debt, forces a debate about the size of government (and spending) before the USA gets to the point of no return. In other words, the debt ceiling is a really good thing.

Moody’s (the rating agency) has said the US should get rid of the debt ceiling altogether, but does this make sense? Greece never had this debate and look what happened to it. They spent their way into oblivion. The debt ceiling could very well keep the US from that same fate. Nonetheless, the professional political class (and this includes the ratings agencies), are trying to scare people with a forecast of Armageddon should the debt ceiling not be increased or lifted.

This is hysteria and politics. Remember the fears about Y2K? Cars won’t start … elevators won’t run … planes will fall out of the sky … ATMs will freeze. How much of that happened? Answer – none of it. A downgrade by ratings agencies, like Moody’s and S&P, or a few days failure to pass a debt ceiling increase, will not make Armageddon happen either.

Let’s be realistic. It is highly unlikely that the United States will “default” on its debt. Every dime of interest will get paid and every penny of principal will be rolled over. The markets understand this and that’s why the government can still borrow money at 3% or less for 10 years. If the markets thought otherwise, interest rates in the US would be 15%. The US is not Greece by a long shot. The US does not need Germany and the IMF to rescue it (like Greece did). The US can pay the principal and the interest. The US has more than enough tax revenue to pay interest on bonds. The ratings agencies know this, as well. But they say, even if the US pays its interest and even if the debt ceiling is raised, they could downgrade US debt for political dysfunction.

Why the hyperbole? Democracy is chaotic, noisy and messy. The US is not insolvent, nor illiquid. The ratings agencies, like many politicians, would like the whole thing to go away, but the Tea Party won’t let it. These are a courageous group of politicians, including Michelle Bachmann (R, MN) who are forcing the government to debate its size and scope.

Don’t be fooled. If it weren’t for the November 2010 elections and the rise of the Tea Party (which includes a huge number of Reagan Democrats and Independents), none of this would be going on right now. Status quo Republicans and Democrats would have already voted on an increase in the debt ceiling and the US would be happily spending its way into a Greece situation. Further, the rating agencies would have ignored the whole matter until a bond auction failed or something dramatic happened.

Three things about this are really bothersome. First, where were the rating agencies when spending was ratcheted up so much? Why are they only speaking out now? Second, massive amounts of spending were done in the name of short-term economic stimulus. Forget whether it worked or not – how did this become permanent spending? And third, what about the economy? The huge increase in government spending has actually hurt the economy contrary to Democratic demagoguery. So cutting back spending will boost growth.

There are models showing that without the large increase in government spending which occurred over the past five or six years, real GDP would be 3.2% larger today ($450 billion) than it is. More important the unemployment rate would be 7.6%, the US would have 2.5 million more jobs and the stock market would be 24% higher (Dow 15,650 and S&P 1660).

The debt ceiling is actually the only tool that might work to stop this steamroller the government is cramming down the throats of Americans. The benefits of using the ceiling, if successful in cutting the size of government relative to GDP, could be huge. Not only would jobs and growth pick up, but the stock market would likely rise, too.

The real issue is whether or not the debate to limit the size of government fails. This is a far greater issue than worrying about the pointless and unjustifiable downgrade by ratings agencies. Smart minds say Investors need to remain calm. Let the politicians be hysterical.

 

This information is compiled by Guy Baker from an assortment of news feeds including First Trust, Yahoo Finance, Bloomburg and others. This information is intended to be informational only. This newsletter contains forward-looking statements about various economic trends and strategies. You are cautioned that such forward-looking statements are subject to significant business, economic and competitive uncertainties and actual results could be materially different. There are no guarantees associated with any forecast and the opinions stated here are subject to change at any time and are the opinion of the individual strategist. Investing involves risk, including the potential for loss of principal. Data comes from the following sources: Census Bureau, Bureau of Labor Statistics, Bureau of Economic Analysis, the Federal Reserve Board, and Haver Analytics. Data is taken from sources generally believed to be reliable but no guarantee is given to its accuracy.

 

 

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