When the most powerful man in the world tells markets that “this time, it’s different”, I think it’s worth taking seriously.
That’s right, Barack Obama told CNBC on Wednesday that investors should be worried about the debt ceiling. Sure, squabbling in Washington is hardly new, but “when you have a situation in which a faction is willing to default on US obligations, then we are in trouble”, he said.
So is Barack right? Should you be concerned?
You’re darned right you should worry
The old ‘this time it’s different’ cliché. Investors seem very blasé about the government shutdown and looming debt ceiling crunch in the States. But Obama cautions: think again!
Before we look at this grave problem, it’s worth considering the difference between the current government shutdown and the debt ceiling, whose October 17 deadline is rapidly looming.
The current impasse, which has seen around 800,000 government workers take forced leave, concerns Obama’s budget proposals. In order to enact his policies, he must get them through Congress. Without agreement, Obama can’t continue day-to-day payments for non-essential government workers. Now, serious as that sounds, it’s not quite a disaster.
The situation is a little like a couple that can’t agree on a new car purchase. He wants a shiny new one; she’s happy to muddle along with the current model – “we can’t afford it!” she says.
The parallel here is Obama’s shiny new Affordable Care Act. Though it may make healthcare affordable for many, the opposition say it’s far from affordable for government. They want to see the whole Obamacare thing put off for a year… they want to wait and see how the land lies then. The current impasse means the family purse is shut tight for anything but the essentials.
The debt ceiling, on the other hand, isn’t so much a family matter – it’s not just a bit of squabbling between the politicians on Capitol Hill. The debt ceiling is effectively the government’s credit card limit. If they can’t keep borrowing money, then you can forget all about Obamacare. These guys won’t even be able to rollover existing debts. And as Obama says, if that’s the case, then investors really should be concerned.
Obama’s bank manager is in over his head
As it happens, Obama has very good relations with his bank manager. I am, of course referring to Ben Bernanke. In fact, the Fed is just as deeply into the same hole as the government. As the great J. Paul Getty said:
“If you owe the bank $100 that’s your problem. If you owe the bank $100 million, that’s the bank’s problem.”
You can add in quite a few noughts to bring this old truism in to line. But the point is, the Fed is up to its neck in loans to the government. The Fed has been busily pursuing a quantitative easing policy buying more and more debt. Bernanke has talked about tapering off these bond purchases, but I’ve made my view on that clear: there will be no taper. The Fed is already in over its head.
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So now the president and his private banker are in a bit of a pickle. Warfare on the Hill means the president can’t continue drawing down on his bank manager’s generous lines of credit. But you see, that’s all the more reason why the Fed will continue scooping up government debt in the markets.
The Fed continues to buy mortgages in the debt markets too. In fact, if the guys on the Hill can’t reach agreement, I expect these purchases to accelerate. The more private debt the Fed scoops up, the more interest payments they skim off the top. They then pass all this income on to the struggling government. What a marvellous thing: to have a friendly bank manager, especially one that can print his own money!
Prepare for a US default, it might just happen
What I find most bizarre about this whole sordid tale is that so few people seem to really care. Yet this could well be the biggest story of our lifetimes. It didn’t get so much as a mention on the late evening news last night – it seems it’s now old news. Nor was it cause for debate on last night’s Question Time – they were busy arguing about Ed Miliband’s fallout with the Daily Mail. And having talked to a mate in New York, it seems most people (other than government officials, of course) calmly went about their business, seemingly unaware that something very nasty could be brewing. There’s certainly none of the fervour associated with the 2008 crisis.
But crises don’t just appear out of thin air. They brew and fester until they suddenly explode onto the scene.
There’s more than a whiff of desensitisation going on here. Your man in the street is pretty sure that the powers that be can and will deal with whatever the markets throw at them. Let alone whatever the guys on Capitol Hill throw at themselves.
And to some degree there’s truth in that – but first we will need to see some mayhem. If the current budget impasse extends to a debt ceiling impasse, then the US government bond market will take a pasting. I mean, if investors stop receiving coupon payments, or the big banks don’t get back billions of dollars of due bonds repayments, then there’ll be a very sudden realisation that this really is serious. After a thirty-year bull market, US bonds could have a very long way to fall!
And in that scenario, I strongly suspect the Fed will indeed come to the rescue. Like I say, they have the printing press, and they’re not afraid to use it. But before we get to that, we’ll have to first walk through the flames of the bond market inferno.
Don’t be blasé about this story. Though the fools on the Hill will probably come to a last minute patchwork deal, failure to do so could wreak havoc with the markets.
What I’m saying is, there’s the potential for a tsunami here. Don’t panic, as it may not happen… but certainly don’t go making any big investments just now – and if you’re looking to cash in some chips, then now could be a good time.
Be mindful. The red flag is up. Let’s see what happens over the coming couple of weeks. And beware, you may have to dig deeper than your standard news sources to see what’s really going on!
That said, have a great weekend. I’m off to play bridge now.
• This article is taken from the free investment email The Right side. Sign up to The Right Side here.
Information in The Right Side is for general information only and is not intended to be relied upon by individual readers in making (or not making) specific investment decisions. The Right Side is an unregulated product published by Fleet Street Publications Ltd. Fleet Street Publications Ltd is authorised and regulated by the Financial Conduct Authority. FCA No 115234. http://www.fsa.gov.uk/register/home.do
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