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Tuesday December 7, 2010 - 18:55:46 GMT
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White House and US Congress Double Down

White House and US Congress Double Down


In due course when the US government can’t borrow near unlimited amounts at very low nominal and real interest rates, the history books will surely talk about a generation squandered.  Not even the world’s largest economy with the world’s reserve currency can play kick the can down the road indefinitely before markets say enough.  Not even when the Federal Reserve is buying Treasuries as fast as the government can issue them.  This is not about near or medium term inflation risks…asset inflation is not broad based inflation, just a key ingredient to boom bust cycle so many officials have chosen over quicker if painful debt restructuring. 


Like most I am not surprised that the White House with leading Republicans and some (probably enough to pass it)  have agreed to extending the Bush tax cuts for everyone, even if the price tag approaches $700bln over the next 2 years.  But to do it just days after the President’s Commission of Deficit Reduction issued its recommendations (11 in favor and 7 against), and after a mid-term election where government deficits was a key message is insulting.  Moreover there are still supply side ideologues peddling this bogus theory that lower tax rates yield more tax receipts.  At the very least the tax cut extension bill should have a no renewal option after 2012 full stop…for all income earners.  But this is not in the cards.  Instead, the 2012 mid-term and presidential election will be run largely on extending the tax cuts.  Nowhere is anyone in Washington talking about tax hikes which are critical to balancing the budget.  Anyone who thinks it all can come from discretionary spending and entitlement cuts is dreaming.  It is all of the above.  Yet we live in a world where assertions matter more than facts and ideology regularly stomps on pragmatism.  Let us not forget that this is bipartisan…the “deal” includes unfunded cuts in payrolls taxes for one year at a cost of $120bln, $5mln estate tax exemption and 35% of anything over $5mln (now zero…great year for the rich to bequeath…and would have gone to 55%) for two years, allowing firms to mark 100% of capital investment in one year and adding another 13 months in unemployment benefits to be funded by increased borrowing.  It is shameful and an indictment of both political parties. 


Is it any wonder that the yield on the US 10-year note pushed above 3.00% today (highest since July) before QE was dragged out by Bernanke and company?  Bernanke and the Fed may well have to increase the size of QE2 in the face of this erosion of confidence in US debt.  Note too that the dollar is again weakening and despite a still horribly handled sovereign debt crisis in Europe that seems further from conclusion than it did two weeks ago with the announcement of a bailout (request) for Ireland.  Speaking of which every European state engaged in fiscal downsizing is mixing tax hikes with spending cuts…there seems to be none of the cynical supply side ideologues directly or indirectly influencing policy in Europe…thank goodness or the place would look like a scene from Mad Max by now.


But any real enactment of Mad Max may well be in the USA so long as it is politics as usual…leadership and sacrifice are the future…not some long-dated wishful option on sacrifice.  Markets won’t stand for this nonsense…especially foreign markets which fund the US deficits…there is nothing patriotic in China’s decision to hold USD and UST.  Maybe they can’t do much with that trade.  But surely they will be less likely to add to the losing position ahead and instead buy other currencies and commodities. 


Frankly how can any rational person be confident in US government in the next few decades getting its arms around the deficit and debt when the opposition party who blew the doors off the deficit in the early 2000’s and is peddling the notion that extending the (unfunded) Bush tax cut to 2% of the highest income earners helps small businesses.  If you believe that Proskauer Rose, Blackstone, Berkshire Hathaway and KKR are small businesses like the corner grocer then I have a condo in Wasilla with a view of Russia you might want to own.  My point is not that the Democrats have a better message, but that if a party with the majority it had in 2008 could not show the utter bankruptcy of the logic of the right in the last two years, they have no business running government.


This is the start of a long period of erosion in global confidence in all things US…foreign policy, fiscal policy, monetary policy and social policy.  The US is on a fast train to a banana republic regardless if it is a GOP express train or the local driven by the Democrats.   As global confidence in the US to do the right thing gets chipped away nearly daily, this has to show up in rates and the dollar even with demonstrations of great incompetence abroad and a Fed Chairman foaming on 60 Minutes about his determination to prevent deflation (which we are told is a near immeasurable risk it is so low) with open ended quantitative easing.      


Start buying 5-year US CDS.


David Gilmore




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