Ready your popcorn, this contrived DC debt ceiling drama is set to go for quite a few rounds.
The latest from the Washington Post:
In a conference call with House Republicans, Speaker John A. Boehner (R-Ohio) said he would press ahead with a two-stage strategy that would give the Treasury only about $1 trillion in additional borrowing authority, forcing another debt-limit battle early next year with the parties in the heat of the 2012 presidential campaign.
“If we stick together, we can win this for the American people,” Boehner told his troops, participants said.
Boehner and Treasury Secretary Timothy F. Geithner appeared on the political talk shows Sunday at the start of a day of crucial talks, and their comments confirmed that the gap between Republicans and the White House on the debt ceiling remains wide and deep.
Geithner warned that a debt-reduction deal that doesn’t result in raising the nation’s legal borrowing limit through the 2012 elections remains unacceptable to the White House and cannot win enough Democratic votes in Congress to ensure passage.
Boehner has apparently never heard of a Pyrrhic victory.
What will be interesting is if the threat voiced by the Administration, namely, the market reaction, isn’t grim. Equities in general are overvalued given the lack of realistic prospects for top line growth (cost cutting may lead to impressive profits, but it’s a self limiting strategy that has gone way beyond its normal sell by date because a fair bit of the cash has propped up prices via stock buybacks) and fragility in the mortgage markets (as one wag said, he never thought he’d get to short subprime twice). Given recent Eurozone-related volatility, anything less than a percent and a half in equity markets signals concern but is well short of panic. And the real test is what happens in Treasuries.
In fact, a muted market reaction works against dealmaking. Both sides will then be playing against what happens when Treasury has to cut payments and limits spending to tax receipts. With Timmie in charge, the last thing he would not pay is Treasuries, and presumably Social Security is his second priority. But the next threat to the officialdom is what oxen get gored when Treasury has to halt payments and how the public reacts. And the other sword of Damocles is a rating agency downgrade. As we and others have noted, this did not affect Japan’s ability to fund cheaply (an item somehow missing from the discourse is that a central bank for a sovereign currency issuer can control yields across the entire yield curve if it wants to; note I’m not saying that that’s great policy, merely that it can be done). And the reports of the last few days indicate that a lot of players who are in theory required to hold all or a certain portion of assets in AAA instruments are getting waivers or otherwise reorienting their lives so as to be able to continue holding Treasuries. That is a long-winded way of saying there are likely to be disruptions, but there is reason to think they will fall short of doomsday scenarios (I’m also skeptical of catastrophic fall of the dollar worries, which is different that expecting the dollar to fall over the longer term. China has a currency band which has a significant dollar component; their peg commits them to buy dollars. The yen is in nosebleed territory relative to the dollar and the Japanese would likely intervene if it gets much higher than it is now).
But the flip side is that the game board has been set up so that there are no winning outcomes for average citizens. Drastic government budget cuts in a deleveraging economy are the equivalent of wearing a hair shirt. That approach has made debt to GDP ratios worse in every country that has tried it in Europe. The brinksmanship, if it leads Treasury to have to stop sending checks, is going to hit the economy harder, faster, both via the direct economic impact and the damage it will do to the mood of the public and businesses, than pretty much every other option under consideration. But the Dems aren’t wrong to be leery of short term kick the can down the road strategies that just assure more Republican efforts at economic hostage-taking. They are likely to lead to a downgrade (and if you doubt my not terribly alarmed view about that, which is contrary to consensus reality, then that is an outcome worth avoiding).
Robert Shiller’s work on bubbles and routs has found that bubbles typically end in the absence of real triggers (or more accurately, the “trigger” is the last buyer going in, which is not a readily observable event and the quasi or actual Ponzi becomes impossible to sustain any longer). The market is overdue for a correction. The banking system in Europe and the US is still on life support (via super cheap interest rates, regulatory forbearance, and other hidden subsidies). So on the one hand, a reversal of some sort is overdue. And the debt mess in the US might be the apparent trigger. I’ve been astonished at how long the officialdom has been able to keep asset values (save US housing) at levels that are out of whack with fundamentals. I’m loath to say that going past August 2 with no deal will break it, but if the lack of resolution goes much beyond that date, all bets are off.