US Debt Ceiling Breached, President Obama to Seek Increase

From the International Business Times,

President Barack Obama will ask Congress to raise the federal debt limit in "a matter of days," White House Press Secretary Jay Carney said on Tuesday.

Although the president was scheduled to ask for $1.2 trillion in additional borrowing authority on Dec. 30, the action was delayed because Congress has only been holding pro forma sessions, meaning no formal business has been conducted. Still, Carney told reporters the White House will request the third and final increase, as determined by the debt-ceiling deal reached by Congress last August.

"I'm confident it will be executed in a matter of days, not weeks," Carney said.

The vote could come as early as Tuesday Jan. 17, after lawmakers officially begin the second session of the 112th Congress.

The U.S. reached the current $15.2 trillion debt limit on Wednesday Jan. 4, The Hill reported. Since then, the federal government has reportedly tapped into its Exchange Stabilization Fund in order to avoid exceeding the limit. The U.S. Treasury Department Web site states the fund consists of three types of assets: U.S. dollars, foreign currencies and Special Drawing Rights.

More signs of the Obama administration’s insatiable appetite for spending… (the following charts from Heritage budget chart book)

…a trend where mounting deficits continue to drive US debt levels vertically

…which if sustained would eventually reach crisis levels.

Yet if other countries desist from funding skyrocketing debt, and with lack of internal savings, this means either default or the Fed’s monetization of debt, that risks an inflation spiral.

It appears that President Obama is on track to take the US to a tipping point or what I call the Mises moment.

Escalating European Crisis Weighs on Global Financial Markets

I don’t think last night’s selloff at Wall Street was mainly about the stalemate or the failure by the special debt-reduction committee to come into an agreement over budget cuts as portrayed by media.

Although I’d say that the extant gloomy sentiment may have been partly aggravated by the above events.

I would further add that the developments at the MF Global Holdings, where shortfall in U.S. segregated customer accounts may exceed $1.2 billion, more than double what was previously expected appears to be more of an influence considering the sharp declines in prices of the commodities.

Although I would reckon that last night’s semi-crash mostly reflected on European debt crisis, which according to reports, have been spreading to the core

From Reuters,

ECB policymaker Juergen Stark warned on Monday the sovereign debt crisis had spread from the euro zone's periphery to its core economies and was affecting economies outside of Europe.

"These are very challenging times... The sovereign debt crisis has re-intensified and is now spreading over to other countries including so-called core countries. This is a new phenomenon," Stark said in a speech to Ireland's Institute of International and European Affairs in Dublin.

"The sovereign debt crisis is not only concentrated in Europe, most advanced economies are facing serious problems with their public debt."

And growing evidence of the banking stress in Europe has been the fund flows (capital flight) to the US Federal Reserve

From Bloomberg

Foreign bank deposits at the Federal Reserve have more than doubled to $715 billion from $350 billion since the end of 2010 amid Europe’s debt turmoil, buttressing the dollar’s status as the world’s reserve currency.

Forty-seven non-U.S. banks held balances of more than $1 billion at the New York Fed as of Sept. 30, up from 22 at the end of 2010, according to a survey of 80 financial institutions by ICAP Plc, the world’s largest inter-dealer broker. The dollar has appreciated 7.2 percent since Standard & Poor’s cut the nation’s AAA credit rating Aug. 5, the second-best performance after the yen among developed-nation peers, according to Bloomberg Correlation-Weighted Currency Indexes.

In what appears to be a choice between two seemingly ‘toxic’ assets, investors have been exiting the EU and has flocked to the US, which alternatively means that US dollar has been winning this round so far.

Politically captive financial markets will remain highly volatile.

US Debt Passes $15 Trillion or Over 100% of GDP

From Zero Hedge,

Too sad for commentary, but here is some math: total US debt has increased by 41.5%, or $4.4 trillion, from $10,626,877,048,913 on January 20, to $15,033,607,255,920, under Obama as president.

(as a reminder the most recently updated debt ceiling is $15.194 trillion)

Some sectors think that the growing US debt dynamic, which has now gone past 100% of the GDP ($14.582 trillion in 2010), won’t pose as a major concern since US debt has been underwritten on their own currency, the US dollar, which means the US can simply monetize her own debts.

Yet as author Adam Fergusson recently said, in citing his experience with the Weimar Germany, this would tantamount to playing with fire.

The unwieldy US debt dynamic is like a ticking time bomb.

Amidst Market Meltdown: The Phisix-ASEAN Divergence Dynamics Holds

The global financial markets and the local equity market have, so far, been confirming my divergence theory.

There are two implications:

One, market correlations has been continually changing. There is no fixed relationship as every political-economic variable has been fluid or in a state of flux.

This only demonstrates the apriorism of the inconstancy and complexity of the market’s behavior, which strengthens the perspective or argument that historical determinism (through charts or math models) can’t accurately predict the outcome of human actions. Even LTCM’s co-founder Myron Scholes recently admitted to such shortcomings[1].

And importantly, the activist policies by global political stewards, aimed at the non-repetition of the events that has led to the global contagion emanating from the Lehman bankruptcy episode of 2008 (which could also be seen as actions to preserve the status quo of political institutions founded on the welfare state-central banking-politically endowed banking system), have been driving this dynamic.

In short, political actions continue to dominate the marketplace[2].

Thus this transition phase has led to the distinctive performances in the relationships among market classes which can be seen across global markets.

Gold as THE Safe Haven

In today’s market distress, market leadership or the flight to safety dynamics has changed as noted last week. The US dollar which used to function as the traditional safehaven currency as in 2008 has given way to the gold backed Swiss franc and the Japanese Yen. This comes in spite of repeated interventions by their respective governments.

Another very significant change in correlations has been that of the US treasuries and gold prices.

Again, while US treasuries had been traditional shock absorber of an environment dominated by risk aversion, this time, it’s not only that gold’s correlation with US Treasuries has significantly tightened, most important is that gold has immensely outperformed US Treasuries since 2009, as shown above[3].

Gold’s assumption of the market leadership points to a vital seismic transition taking place.

Let me repeat, since gold has not been used as medium for payment and settlement, in an environment of deleveraging and liquidation, gold’s record run can’t be seen as in reaction to deflation fears but from expectations over aggressive inflationary stance by policymakers.

Arguments that point to the possible reaction of gold prices to ‘confiscatory deflation’, as in the case of the Argentine crisis of 2000, is simply unfounded; Gold priced in Argentine Pesos remained flat during the time when Argentine authorities imposed policies that confiscated private property through the banking system, but eventually flew when such policies had been relaxed and had been funded by a jump in money supply via devaluation[4].

Gold’s recent phenomenal rise has been parabolic! Gold has essentially skyrocketed by $1,050+ in less than TWO weeks! Gold prices jumped by 6% this week. The vertiginous ascent means gold prices may be susceptible to a sharp downside action (similar to Silver early this year) from profit takers.

Nonetheless gold’s relationship with other commodities has also deviated.

The correlations between gold and energy (Dow Jones UBS Energy—DJAEN) and industrial metals Dow Jones-UBS Industrial Metals—DJIAN) has turned negative, as the latter two has been on a downtrend.

However the Food or agricultural prices (represented by S&P GSCI Agricultural Index Spot Price GKX) appear to have broken out of the consolidation phase to possibly join Gold’s ascendancy.

The breakdown in correlations do not suggest of a deflationary environment but rather a ongoing distress in the monetary affairs of crisis affected nations.

The Continuing Phisix-ASEAN Divergences

The same divergence dynamics can be seen in global stock markets.

While markets in the US (SPX), Europe (STOX50) and Asia Ex-Japan (P2Dow) have been sizably down, the Philippine Phisix (as well as major ASEAN indices) appears to defy these trends or has been the least affected.

One would further note that Asian markets, despite the similar downtrends has still outperformed the US and Europe, measured in terms of having lesser degree of losses.

A broader picture of this week’s performance reveals that the ASEAN-4 has been mixed even in the face of a global equity market meltdown.

Thailand and the Philippines posted marginal gains while Malaysia was unchanged. Topnotch Indonesia suffered the most but still substantially less than the losses accounted for by major bourses.

Vietnam, which has been in a bear market, saw the largest weekly gain which may have reflected on a ‘dead cat’s bounce’, whereas Singapore endured hefty losses which also reflected on the contagion of losses from major economy bourses.

The above chart signifies as more evidence that has been reinforcing my divergence theory.

Yet growing aberrations are not only being manifested in stock markets but also in the region’s currency.

Previously, a milieu of heightened risk aversion entailed a run on regional currencies.

Today, the seeming resiliency of the ASEAN-4’s equity markets appears to also be reflected on their respective currencies.

Three weeks of global market convulsion hardly dinted on the short term uptrend of ASEAN-4 currencies seen in the chart from Yahoo Finance in pecking order Philippine peso, Indonesia rupiah, Thai baht and the Malaysian ringgit.

And when seen from the frame of the Peso-Phisix relationship, the recent selloffs share the same divergent (the actions of major economies) outlook.

The Phisix (black candle) appears to have broken down from its short term trend (light blue trend line), so as with the US-dollar Philippine Peso (green trendline) which had a breakout (breakouts marked by blue circle/ellipses) during the week.

Since I don’t subscribe to the oversimplistic nature of mechanical charting, but rather see charts as guidepost underpinned by much stronger forces of praxeology (logic of human action), we need to look at the bigger picture.

The sympathy breakdown by the Phisix, the other week, has not been supported by the broad market.

Market breadth continues to suggest that present activities have been characterized by rotational activities and consolidations rather than broad market deterioration.

Weekly advance-decline spread, which measures market sentiments has improved from last week, even if the differentials posted slight losses (left window).

Foreign buying turned slightly NET positive (right window).

One would further note that sectoral performance had been equally divided.

Services led by PLDT [PSE: TEL] along with the Holding sector, mostly from Aboitiz Equity Ventures [PSE: AEV] and SM Investments [PSE: SM] provided contributed materially to the gains of the Phisix.

The Mining industry closed the week almost at par with the performance of the local benchmark, while Financial Industrial and the property sectors fell. Again signs of rotations and consolidations at work.

These empirical evidences seem to suggest that the short term breakdown by the Phisix and the Peso may not constitute an inflection point. This will continue to hold true unless exogenous forces exert more influence than the current underlying dynamics suggests.

Money Supply Growth Plus Policy Activism Equals Low Chance of a US Recession

As I repeatedly keep emphasizing, it is unclear if such divergence dynamics could be sustained under a contagion from full blown recession or in crisis, because if it does, this would translate to decoupling.

In other words, divergence dynamics is NOT likely immune to major recessions or crisis until proven otherwise.

Yet despite many signs that appear to indicate for a sharp economic slowdown which many have said increases the recession risks in the US or the Eurozone, very important leading indicators suggest that this won’t be happening.

Importantly, the deep-seated bailout culture (Bernanke Put or Bernanke doctrine) practiced by the current crop of policymakers or the ‘activist’ stance in policymaking would likely introduce more monetary easing measures that could defer the unwinding of the imbalances built into the system.

In other words, I don’t share the view that the US will fall into a recession as many popular analysts claim.

For one, excess reserves held by the US Federal Reserves appears to have topped out (WRESBAL-lowest pane).

And this comes in the face of the recent surge in consumer lending (Total Consumer Credit Outstanding; TotalSL-highest pane). Also we are seeing signs of recovery in Industrial and Business Loans (Busloans-mid pane).

So, perhaps the US banking system could be diverting these excess reserves held at the US Federal Reserve into loans. And once this motion intensifies, this will first be read as a “boom”, which will be followed by acceleration of consumer price inflation and an eventual “bust”.

Yet it’s plain nonsense or naive to say that monetary policies have been “impotent”.

First, ZERO interest rates, which has been and will be used as the deflationary bogeyman, are exactly the selfsame excuse needed by central bankers to engage in activist policymaking (print money).

Policy ‘impotence’ would happen when inflation and interest rates are abnormally high.

Second, growing risks of recessions or crises has been the oft deployed justification to impose crisis avoidance or ‘stability’ measures. Crisis conditions gives politicians the opportunity to expand political control or what I would call the Emmanuel Rahm doctrine or creed.

The debt ceiling deal had been reached from the same fear based ‘Armaggedon’ strategy. And so has the Troubled Asset Relief Program (TARP) under the Emergency Economic Stabilization Act of 2008[5] where the ensuing market crash from the failed first vote led to its eventual legislation.

Morgan Stanley’s Joachim Fels and Manoj Pradhan thinks that the current predicament has likewise been a policy induced slowdown.

Mr. Fels and Pradhan writes[6],

There are three main reasons for our downgrade. First, the recent incoming data, especially in the US and the euro area, have been disappointing, suggesting less momentum into 2H11 and pushing down full-year 2011 estimates. Second, recent policy errors - especially Europe's slow and insufficient response to the sovereign crisis and the drama around lifting the US debt ceiling - have weighed down on financial markets and eroded business and consumer confidence. A negative feedback loop between weak growth and soggy asset markets now appears to be in the making in Europe and the US. This should be aggravated by the prospect of fiscal tightening in the US and Europe.

While we see this as being policy induced, where I differ from the above analysts is that they see these as policy errors, I don’t.

I have been saying that since QE 2.0 has been unpopularly received, extending the same policies would need political conditions that would warrant its acceptabilty. Thus, I have been saying that current environments has been orchestrated or designed to meet such goals[7].

Fear is likely the justification for the next round of QE.

As I recently quoted an analyst[8],

But the political imperative will be to do something… anything… immediately, to ward off disaster.

Importantly, a survey of fund manageers sees a jump of expectations for QE[9].

Expectations of QE3 have doubled: 60% now see 1,100 points or below on the S&P500 Index as a trigger for QE3, up from 28% last month, and global fiscal policy is now described as restrictive for the first time since March 2009.

And we seem to be seeing more clues to the US Federal Reserve’s next asset purchasing measures.

Late last week, the US Federal Reserve has extended a $200 million loan facility via currency swap lines to the Swiss National Bank (SNB), as an unidentified European bank reportedly secured a $500 million emergency loan[10]. This essentially validates my suspicion that the so-called currency intervention by the SNB camouflaged its true purpose, i.e. the extension of liquidity to distressed banks, whose woes have been ventilated on the equity markets.

Moreover a Wall Street Journal article[11] implies that the solution (panacea) to the European banking woes should be more QEs.

Foreign banks that lack extensive U.S. branch networks have a handful of ways to bankroll U.S. operations. They can borrow dollars from money-market funds, central banks or other commercial banks. Or they can swap their home currencies, such as euros, for dollars in the foreign-exchange market. The problem is, most of those options can vanish in a crisis.

Until recently, that hasn't been a problem. Thanks partly to the Federal Reserve's so-called quantitative-easing program, huge amounts of dollars have been sloshing around the financial system, and much of it has landed at international banks, according to weekly Fed reports on bank balance sheets.

So rescuing the Euro banking system would mean a reciprocal arrangement since these banks, under normal conditions would be buying or financing the US deficits via the treasury markets. So by extending funding through the currency swap lines, the US Federal Reserve has essentially commenced a footstep into QE 3.0.

Third, suggestions that grassroots politics would impact central bank policymaking is simply groundless. The general public has insufficient knowledge on the esoteric activities of central bankers.

Henry Ford was popularly quoted that

It is well enough that people of the nation do not understand our banking and monetary system, for if they did, I believe there would be a revolution before tomorrow morning.

That’s why the US Federal Reserve has successfuly encroached on the fiscal realm via QE 1.0 and 2.0 with little political opposition. The current political opposition has been focused on the fiscal front yet the debt ceiling bill sailed through it. Yet in case the public’s outcry for the fiscal reform does intensify, any austerity will likely be furtively channeled to central bank manueverings.

Thus, with foundering equity markets, rising credit risk environment which risks undermining the US-Euro banking system, a higher debt ceiling, and a sharp economic slowdown, the current environment seems ripe for the picking. It will be an opportunity which Bernanke is likely to seize.

The annual meeting of global central bankers at Jackson Hole, Wyomming hosted by the Kansas City Fed meeting next week could be the momentous event where US Federal Reserve Chair Ben Bernanke may unleash his second measure “another round of asset purchases” which he communicated[12] last July 13^th. This follows his first “explicit guidance” outline for a zero bound rate which had recently been made into a policy[13] (zero bound rate until mid-2013)

All these seamlessly explains the newfound gold-US treasury ‘flight to safety’ correlations.

Global financial markets addicted to money printing has been waiting for the “Bernanke Put” moment. For them, current measures have NOT been enough, and they are starving for another rescue.

---

[1] See Confessions of an Econometrician August 19, 2011

[2] See Global Equity Meltdown: Political Actions to Save Global Banks, August 14,2011

[3] Gayed Michael A. Gold = Treasuries, Ritholtz.com, August 18, 2011

[4] See Confiscatory Deflation and Gold Prices, August 15, 2011

[5] Wikipedia.org First House vote, September 29 Emergency Economic Stabilization Act of 2008

[6] Fels, Joachim and Pradhan, Manoj Dangerously Close to Recession, Morgan Stanley, August 19, 2011

[7] See Global Market Crash Points to QE 3.0, August 7, 2011

[8] See The Policy Making Moral Hazard: The Bailout Mentality, August 20, 2011

[9] Finance Asia Investors slash equities, pile into cash amid growth fears, August 18, 2011

[10] See US Federal Reserve Acts on Concerns over Europe’s Funding Problems, August 19, 2011

[11] Wall Street Journal Fed Eyes European Banks, August 18, 2011

[12] See Ben Bernanke Hints at QE 3.0, July 13 2011

[13] See Global Equity Meltdown: Political Actions to Save Global Banks, August 14, 2011

Debt Addiction: US borrowing tops 100% of GDP

I forgot to post this earlier.

The floodgates for borrowing has opened.

From Yahoo,

US debt shot up $238 billion to reach 100 percent of gross domestic project after the government's debt ceiling was lifted, Treasury figures showed Wednesday.

Treasury borrowing jumped Tuesday, the data showed, immediately after President Barack Obama signed into law an increase in the debt ceiling as the country's spending commitments reached a breaking point and it threatened to default on its debt.

The new borrowing took total public debt to $14.58 trillion, over end-2010 GDP of $14.53 trillion, and putting it in a league with highly indebted countries like Italy and Belgium.

Public debt subject to the official debt limit -- a slightly tighter definition -- was $14.53 trillion as of the end of Tuesday, rising from the previous official cap of $14.29 trillion a day earlier.

Treasury had used extraordinary measures to hold under the $14.29 trillion cap since reaching it on May 16, while politicians battled over it and over addressing the country's bloating deficit.

The official limit was hiked $400 billion on Tuesday and will be increased in stages over the next 18 months.

Here are some noteworthy debt charts

From the Economist

From Britannica

Addiction to acquiring debt has not been limited by political party.

Outside Japan JP and Belgium BE, the US approaches the debt levels of today’s crisis stricken nations of Portugal PT, Italy IT and Greece GR (chart from Deutsche Bank)

What is unsustainable won’t last.

Return of the Bond Vigilantes? China and Russia Blasts Debt Ceiling Bill

Back to the debt ceiling bill, foreigners as the BRICs represent as pivotal forces, whom could function as bond vigilantes (bond market investors who protests monetary or fiscal policies they consider inflationary by selling bonds, thus increasing yields) and who could substantially sway US sovereign bond prices or the direction of interest rates.

Some of these significant bond holders have reportedly criticized the debt bill.

From Bloomberg,

China, the largest foreign investor in U.S. government securities, joined Russia in criticizing American policy makers for failing to ensure borrowing is reined in after a stopgap deal to raise the nation’s debt limit.

People’s Bank of China Governor Zhou Xiaochuan said China’s central bank will monitor U.S. efforts to tackle its debt, and state-run Xinhua News Agency blasted what it called the “madcap” brinksmanship of American lawmakers. Russian Prime Minister Vladimir Putin said two days ago that the U.S. is in a way “leeching on the world economy.”

The comments reflect concern that the U.S. may lose its AAA sovereign rating after President Barack Obama and Congress put off decisions on spending cuts and tax increases to assure enactment of a boost in borrowing authority. China and Russia, holding a total $1.28 trillion of Treasuries, have lost nothing so far in the wake of a rally in the securities this year.

“It’s probably frustration more than anything else for China,” said Brian Jackson, a senior strategist at Royal Bank of Canada in Hong Kong. While the nation has concerns, “they realize there’s not a lot of options for them out there and so they need to keep buying Treasuries.”

China held $1.16 trillion of Treasuries as of May, U.S. Treasury Department data show. The nation has accumulated the holdings as a by-product of holding down the value of its currency, a policy U.S. officials have said gives China an unfair advantage in trade.

Apparently these have not just been political talk but appear to have been accompanied by action

Charts from yardeni.com

Foreign appetite for US bonds has been on a decline, with China accounting for the gist.

As earlier discussed, the local savers through private banks have been shackled by various regulations particularly the Basel Accords, which compels the banking industry to divert these savings to finance government expenditures. This has been called as Financial Repression by some experts. Once the bond market unravels, many of the private sector money tied due to such regulations will get burned.

Yet with the debt ceiling bill currently lifted to $16.5 trillion, and where the US Federal Reserve has taken over the bulk of the financing of the ballooning US deficits via the QE 2.0 from declining interests from foreigners, the $64 gazillion question is ‘will the US government allow interest rates to go up which increases the risks of popping the banking system’s ultra fragile balance sheets?’

Graphic above from PIMCO’s Bill Gross

I don’t think so.

And it has been part of the central banking dogma or quasi operating manual to inflate the system when some form of distress emerges.

This can be exemplified by the actions of the SNB on the Swiss Franc and the BoJ on the Yen during the past 24 hours. And that’s why, given the mounting risks of a bond auction failure, sluggish asset markets and the desire to keep interest rates at current levels or ‘Zero bound’, we should expect the next round of asset purchases by the US Fed to happen soon.

And this is also why fissures on the US dollar system continue to widen.

From another Bloomberg article

The committee of bond dealers and investors that advises the U.S. Treasury said the dollar’s status as the world’s reserve currency “appears to be slipping” in quarterly feedback presented to the government.

The Treasury Borrowing Advisory Committee, which includes representatives from firms ranging from Goldman Sachs Group Inc. to Pacific Investment Management Co., said the outperformance of haven currencies and those from emerging nations has aided in the debasement of the dollar’s reserve status, according to comments included in discussion charts presented ahead of the quarterly refunding. The Treasury published the documents today.

“The idea of a reserve currency is that it is built on strength, not typically that it is ‘best among poor choices’,” page 35 of the presentation made by one committee member said. “The fact that there are not currently viable alternatives to the U.S. dollar is a hollow victory and perhaps portends a deteriorating fate.”

What is unsustainable won’t last. The bond vigilantes are lurking around the corner and substantially higher interest rates will be the future. That’s what record gold prices have been admonishing us.

For now, profit from political folly.

(hat tip Dr. Antony Mueller)

Debt Ceiling Bill: Where are the Spending Cuts?

I correctly argued that the so-called debt deal impasse was only a theatrical display meant to pander to voters (and the tea party movement) that there has been a standing opposition.

In truth, politicians from both camps had no desire to enact fiscal discipline. Instead, they colluded to use market hobgoblins to arrive at the 11^th hour deal.

Now that the debt ceiling deal had been passed at the Congress, we ask; where are the spending cuts?

Cato’s Chris Edwards says there’s none

More from Mr. Edwards,

the budget deal doesn’t cut federal spending at all.

House Speaker John Boehner’s bullet points on the deal say that it cuts discretionary spending by $917 billion over 10 years, as “certified by CBO.” These discretionary “cuts” appear to be the same as those in Boehner’s plan from last week. The chart shows CBO’s scoring of those spending cuts.

Wait a minute, those bars are rising! Spending isn’t being cut at all. The “cuts” in the deal are only cuts from the CBO “baseline,” which is a Washington construct of ever-rising spending. And even these “cuts” from the baseline include $156 billion of interest savings, which are imaginary because the underlying cuts are imaginary.

No program or agency terminations are identified in the deal. None of the vast armada of federal subsidies are targeted for elimination. Old folks will continue to gorge themselves on inflated benefits paid for by young families and future generations. None of Senator Tom Coburn’s or Senator Rand Paul’s specific cuts were included.

The federal government will still run a deficit of $1 trillion next year. This deal will “cut” the 2012 budget of $3.6 trillion by just $22 billion, or less than 1 percent.

The legislation does create a “Joint Committee” to design a second round of at least $1.2 trillion in spending cuts by November. Presumably, interest savings will be included in those “cuts” as well, reducing the amount of actual program cuts needed to about $1 trillion.

The debt ceiling bill looks more like legal skulduggery or prestidigitation

As Cato’s David Boaz neatly puts its

most of which promise to cut spending some day—not this year, not next year, but swear to God some time in the next ten years. As the White Queen said to Alice, ”Jam to-morrow and jam yesterday—but never jam to-day.” Cuts tomorrow and cuts in the out-years—but never cuts today.

Now that debt ceiling has been raised, expect the next round of asset purchase program from the US Federal Reserve

Hot: Debt Limit Deal Approved

From Bloomberg, (bold emphasis mine)

President Barack Obama said tonight that leaders of both parties in the U.S. House and Senate had approved an agreement to raise the nation’s debt ceiling by $2.1 trillion and cut the federal deficit by as much as $2.5 trillion over a decade, a deal that must now be sold to Congress.

“The leaders of both parties in both chambers have reached an agreement that will reduce the deficit and avoid default,” Obama said at the White House. “This compromise does make a serious down payment on the deficit-reduction we need. Most importantly it will allow us to avoid default.”

Congressional leaders reached a bipartisan agreement to raise the debt ceiling by at least $2.1 trillion, sufficient to serve the nation’s needs into 2013. They are preparing to sell to members the deal to cut $917 billion in spending over a decade, raising the debt limit initially by $900 billion, and to charge a special committee with finding another $1.5 trillion in deficit savings by the year’s end. They confront an Aug. 2 deadline for approval of the agreement.

I told you so.

How the US Debt Ceiling Crisis Affects Global Financial Markets

In my own time, governments have taken the place of people. They have also taken the place of God. Governments speak for people, dream for them, and determine, absurdly, their lives and deaths. Ben Hecht in Perfidy (via David Harsanyi)

Any moment now the ‘divisive’ issue over the US debt ceiling will likely reach settlement.

And by this I mean that the debt ceiling will be raised and that a landmark deal will be made over fiscal dynamics of the US in the coming years.

The supposed GOP Boehner Bill HR 2693 which recently passed the House[1] but was rejected by the Senate[2] already exposed such eventuality. That’s because the House bill proposed a new debt ceiling from US $14.294 trillion[3] to possibly $16.994 trillion—a figure cited by Zero Hedge[4]!

If this is true then such an increase would largely depend on the willingness of foreigners to finance the US government. Otherwise, we should expect the US Federal Reserve to step up the plate[5] with serial asset purchasing programs or interest rates in the US will rise that could heighten risks of the highly leveraged banking system, and equally, menace the deep in the hock US government.

What is being deliberated in real time is the mechanics governing the debt ceiling bill. On what increasingly seems like ‘staged dispute’ supposedly based on ‘ideology’—cut along party lines of tax increases versus government spending, the emerging compromise will account for a farcical display of attaining fiscal discipline.

As of this writing, the Bloomberg reports a working framework being threshed out[6],

The tentative framework includes immediate spending cuts of $1 trillion and creation of a special committee to recommend additional savings of up to $1.8 trillion later this year. The new panel would have to act before the Thanksgiving congressional recess in late November and Congress would have to approve its recommendations by late December or government departments and programs, including defense and Medicare, would face automatic, across-the-board cuts, the person said.

No more than 4 percent of Medicare would be subject to cuts, and beneficiaries would be unaffected as reductions would apply to providers, the person said. Social Security would be untouched.

These proposed spending cuts will likely signify as reduction in the growth rate of future spending, rather than actual spending cuts. In addition “additional savings” are likely to come in the form of tax increases.

What gradually is being revealed is that the “extend and pretend” or “kick the can down the road” policies would only widen the door for more inflationism that would set up a major crisis down the road that would make 2008 pale in comparison.

The kernel of the US debt ceiling crisis has been encapsulated by the chart below from the Wall Street Journal.

As the Wall Street Journal editorial accurately writes[7],

This is the road to fiscal perdition. The looming debt downgrade only confirms what everyone knows: Congress has made so many promises to so many Americans that there is no conceivable way those promises can be kept. Tax rates might have to rise to 60%, 70%, even 80% to raise the revenues to finance these promises, but that would be economically ruinous.

As writing on the Wall, there have been three credit rating agencies, outside the largest, that has downgraded the credit standing of the US, namely Weiss Ratings, Egan-Jones Ratings Co. and Beijing based Dagong Global Credit Rating[8]

The left believes that an inexhaustible Santa Claus fund exists to finance political programs which would hardly affect the distribution of resources or how the economy operates. They see the world in a prism of social stasis, where people’s actions are homogenous and can be easily manipulated.

The left believes that forcing others to pay for supposed “rights”, or in actuality, for veiled privileges that benefits vested interest groups in the name of social welfare—they would advance the cause of the economy. They ignore the reality that resources are scarce and forced redistribution represents a zero sum game-where one benefits at the expense of the other. Yet, the politically blinded left never seem to realize that restricting choices available to people leads to violence.

And worst, markets are increasingly being held hostage by political brinkmanship as political leaders try to extract negotiation leverage by spooking the marketplace with veiled threats of Armageddon[9]

The great libertarian H. L. Mencken was eloquently precise when he wrote[10]

Civilization, in fact, grows more and more maudlin and hysterical; especially under democracy it tends to degenerate into a mere combat of crazes; the whole aim of practical politics is to keep the populace alarmed (and hence clamorous to be led to safety) by an endless series of hobgoblins, most of them imaginary.

Part of such endless series of hobgoblins to promote expansive government power and unsustainable welfare programs grounded on the antics of ‘default’ has resulted to the dramatic flattening of the US yield curve (stockcharts.com).

The spike in the 3 month T-Bills runs in contrast to the actions on the longer maturity term structure, which registered declines in the yields and thus the flattening of the curve.

Add to these has been the recent languor seen in major global equity markets and another record run in gold prices.

US equities represented by the S&P 500 fell sharply this week (3.92%) while the volatility index (VIX) spiked along with it. In addition, the debt issue has weighed on the US dollar (USD).

So essentially, gold prices seem to tell us that there would be more inflation ahead.

Hence political bickering and jawboning have placed considerable stress in the marketplace.

Again, this shows that in today’s milieu neither economics nor corporate fundamentals determine the direction of markets but political developments, which runs in defiance of conventional wisdom.

The fact is that the US has been in a covert default mode, through consecutive Quantitative Easing or credit easing, the purchasing power of the US has been on a decline. The current purchasing power of the US dollar has been lower than when these debts had been contracted. Thus the stealth default.

As Murray N. Rothbard wrote[11],

Inflation, then, is an underhanded and terribly destructive way of indirectly repudiating the "public debt"; destructive because it ruins the currency unit, which individuals and businesses depend upon for calculating all their economic decisions.

Unless politicians face up to these realities, the US will default sooner or later. And much of these near term moves to default will be through inflationism.

And again policy choices or political direction is likely to be path dependent in accordance to how political institutions have been designed; fundamentally to sustain or preserve the status quo of the cartelized system of central banks-‘too big to fail’ banking system-welfare based government.

At the end of the day, the debt ceiling will be raised and inflationism will prevail, as day of reckoning will be postponed.

All these will be reflected on the marketplace.

Again profit from political folly.

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[1] Yahoo.com House passes Boehner’s debt ceiling plan–and Senate puts it on ice, July 29,2011

[2] USA Today House rejects Senate debt bill; Obama wants compromise, July 30, 2011

[3] Wikipedia.org 2011 U.S. debt ceiling crisis

[4] Zero Hedge, Here Is Boehner's Amended Amended Bill, July 29, 2011

[5] See Falling Markets, QE 3.0 and Propaganda June 12, 2011

[6] Bloomberg.com Deal Framework Reached on Raising U.S. Debt Ceiling, July 31, 2011

[7] Wall Street Editorial The Road to a Downgrade A short history of the entitlement state. July 28, 2011

[8] US News Money Meet 3 Ratings Agencies That Have Already Downgraded the U.S., July 22, 2011

[9] Guardian.co.uk US debt battle: Showdown on Capitol Hill, July 18, 2011

[10] Wikiquote.org H. L. Mencken

[11] Murray N. Rothbard Repudiate the National Debt, lewrockwell.com