They will get rid of the debt ceiling (at some point)

By Ben Turney.

Last week’s joyous market rally, in response to the Republican offer to extend the debt ceiling by six weeks, was absurd. Quite exactly why a marginal stay of execution was a reason to buy stocks is beyond me. American politicians have had over two years to reach a resolution, since the deficit ceiling became a full-blown crisis, so why should we have expected any magic after six more weeks?

But whatever the case, clearly this time was reason enough for stocks. On reflection, I suppose it’s quite simple really. When the market wants to go up, it goes up, defying logic and reason. Either you choose to go with it or you get out of the way. For what it’s worth, I’m electing to do the latter for the time being.

My problem is I’m not certain Congress and the Whitehouse are going to reach a deal this time. After two exceptionally near misses, the prevailing consensus is that the brinksmanship will give way to a last minute solution, once again. The chances are this will happen, as none of the politicians want to be responsible for overseeing America’s first federal default. However, the contrarian in me senses enough of a risk to be concerned, but not enough to trade this (at least not yet).

When a default happens (which it surely must at some point) it will be a watershed. It will blow away the economic certainties we’ve become accustomed to and we will find ourselves, very suddenly, living in a new and uncertain world, characterised by financial instability.

This is just part of the historical pattern of large scale economic adjustment. There is no reason to believe we have somehow broken free from this cycle. Sure, the Bernanke-inspired “accommodative” monetary policies around the world may have bought us a few more years, but the trend is clear.

There is too much debt. We don’t earn enough to repay the debt. There isn’t the desire or will to enact the necessary reforms to rebalance the books. Deficit spending is being monetised through money creation (in fact excess bank reserves; see the October edition of SpreadBet Magazine for further explanation).

This situation cannot last forever. Current monetary policy distorts free markets and sustains what otherwise must fail. Sooner or later, true market forces will reassert themselves, as they always do.  When that happens we are all in for a shock.  

In the meantime we have yet another “deficit deal” to look forward to.

If we’ve learned anything from the last few years, it is that our politicians are out of ideas about how to resolve the global debt crisis. The problem is too big, the few remaining choices are too tough and they are too weak to do what is necessary.

At the moment, each time the latest debt limit is reached, the Republicans seize this as an opportunity to bash Obama and his social welfare programmes. This political opportunism is all well and good, but will only last as long as the Democrats don’t draw a line in the sand and refuse to accept this anymore. There are signs this is happening now and it looks increasingly likely we are going to see a Republican climb down in the coming days.

The result will almost certainly be another 6-12 month extension of the deficit ceiling, but I wonder if a longer term “solution” might be proposed. In the absence of any genuine systemic fixes, I can’t help but wonder why the US sticks with the deficit ceiling?

Although it is clearly a prudent measure, designed to encourage responsible spending by government, these are neither prudent nor responsible times. The removal of the deficit ceiling would be tantamount to admitting federal spending is completely out of control, but this regular game of high-stakes chicken is wearing on voter patience. If the Democrats are able to ruin the Republican fun and games, both sides could well see it in their interests to remove this obstacle.

If this happens, buy gold!