The United States debt ceiling debacle completely missed the golden opportunity to introduce a complete overhaul to reverse the years of folly that got us into this mess. Lawmakers failed to realize the underlying problem - the US has been abused, and it is time to heal it for good. A while back, this blog reported that talks were in progress to craft SDRs (a basket of currencies) to replace the US Dollar as the world's reserve currency. My analysis of this was that the US was beholden to the world's demand in spite of its domestic issues. Issues that included fiscal woes following the decision to leave the gold standard and accumulate an unsustainable supply of dollars to fuel world demand for more US debt. The cycle continued as the world progressed (case in point: the emerging economies off the back of US pain -- China, the biggest holder of our debt). Congress, given the constitutional power of the purse, has yet to realize that we are being played continuously. Recently, Russia's Putin stated that the US is a parasite to the world. China continues to lecture us on how to reverse our addiction to pleasing the world with debt, because it is no longer sustainable for their country as it moves past our problems. And now, our own private markets have raised the alarm. Standard & Poors steps into the debate.
The downgrade from AAA to AA+ is primarily because of the deficit deal reached by lawmakers one day before the debt ceiling deadline. It was merely a band-aid approach to calm markets, and shifts responsibility to a committee that must use politics to decide what government program will receive a cut. With something so nonsensical, a downgrade is inevitable, no need to be shocked. The structural problems have yet to be addressed.
Lower GDP, and what seems to be better jobs numbers at face value, sent lawmakers reassuring the American people that this is just a short term thing, and the economy will get better...in their hands. Almost laughable to watch this play out. A deeper look into the data shows that the labor market has continued to decline, and because of our messy approach to employment statistics, a drop in the labor market means that the troubled Americans in search of work have left the pool, and the active few (some of whom successful in finding employment) provide a boost to the data. This is correlated to a structural problem, in which the supply of labor is due to an unskilled workforce. Businesses need skilled thinkers to cut through the problems created by the government, and pave the way to recovery. Instead, we have many Americans who are the result of failed government programs with no where to go. And now lawmakers must accommodate for this weird skew with budget shifts.
The structural problem is not entirely American. The European Union continues to struggle with a way to balance the needs of constituents and bond holders. EU's Rehn recently urged everyone to stay calm and breathe deeply as officials try to craft a plan for Greece to continue borrowing at low costs, with less fiscal burdens due to austerity measures, all while making sure that current bond holders receive their fair share. It's a complex mess that will take time to correct. The markets are not impressed.
Italy rushed through an entire austerity package in one week, under pressure by the EU to make sure that the country is in good shape in case of contagion disaster. Italy is a major route for European debt, so there is big internal worry that they remain solvent. Yields on Italian debt surged as investors panicked and withdrew money from its bonds. The backroom deals sent a message that there are more problems to come. There is hope in Spain as yields decreased with an improving stock market. But, these spreads between Italian, Spanish, and German yields show that the movement of cash within Europe is due to uncertainty.
US markets experienced a significant decline this week, as the Dow Average moved into the red for this year. Safe havens are now at risk of a price drop too. Margin calls were a major factor in the drop in Gold and Silver prices as investors needed to exit positions in commodities for liquid cash to cover riskier investments in stocks, all to maintain a balanced portfolio. The intense movement of cash to Switzerland caused the Swiss Franc to rally. However, the Swiss Government saw this as too cumbersome a risk to foreign banking demand; thus in an effort to remain stabilized, its Central Bank cut rates to calm the markets.
US Treasury bills are still in hot demand, and this is somewhat problematic. Investors have no where to go, and Treasuries will continue to be a safer alternative. However, with the US now on "negative outlook" by S&P, the supply and demand of Treasury Bills at auction is uncertain. States have already started buckling up with less debt accumulation. The lower supply of municipal bonds are good for the state's sustainable budget goals, but leaves investors hoarding more cash.
The Financial Times accurately calls this a liquidity trap - the 2011 deposit crisis. Banks like BNY Mellon are charging more for services that are costing them. The service of hoarding depositor cash in savings is not feasible. Banks have the duty to utilize your savings to provide interest returns. However, with no utilization of cash because of global uncertainty, they rather avoid having to be pressured into risk.
So, what can be done? The government should shift from spending to investment. As much as there is a spending problem, governments are in desperate need of revenue to please bondholders. Taxes should not be the only source of revenue. Government services need to be measured by its affect on producing a good supply of labor, which will in turn utilize the assets created by government (infrastructure, education, etc) to enhance their well-being. Every project must have ROI in mind. States are in a better position to do this well by making sure that each municipal bond issued must have a plan of repayment with ROI instead of new debt. We desperately need to send a signal to the markets that the US is back in business.
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