Shutdown!

04/10/2013 at 5:31 pm

The United States has been a source of much consternation this year. First of all the Federal Reserve accidentally triggered a mild panic over one of its least efficacious policy programmes. Then Congress deliberately threatened to push the nation towards default to force the government’s hand over legislation passed by itself in 2010. It is almost as if elected representatives in Washington have become so disappointed with the failure of their European counterparts to provoke another global financial meltdown that they have decided to do the job themselves. This is an unusual attitude to American exceptionalism. And it is hardly intuitive to wave the cudgel of a selective default on US debt while claiming to do so in an attempt to bring US debt under control.

However, what Warren Buffett has rightly called the “extreme idiocy” of the present position has not had that much of an effect. This seems incredible given what might technically be at stake. Already, 70% of intelligence staff have been placed on unpaid leave; just enough employees at the Department of Energy have been left in post to discharge their responsibilities to supervise the nation’s nuclear stockpile; diplomacy has already been affected, though troops are still to be paid (and the postal service remains in operation). And yet the S&P 500 is only 2% off its record high of a couple of weeks ago. The trade weighted dollar has tumbled all of 1% over the same period. Credit default swaps – which are priced specifically to insure against the risk of sovereign default – have admittedly ticked up a bit, but only to 42bp. That isn’t even the high for the year. According to Bloomberg the US still prices in this market as the sixth safest debtor in the world (between Britain and New Zealand).

Compare and contrast this picture with the down-to-the-wire debt ceiling negotiations of July and August 2011. Back then there was pandemonium. President Obama and Congress between them hammered out a complex package of fiscal arrangements and at the eleventh hour managed to avoid the shutdown we’re now seeing – and markets collapsed. The meltdown which accompanied the events of that summer was truly savage (see this blog’s coverage here and here).

Something has clearly changed.

As was apparent from the start in 2011, the real trigger for the crash was not the political turmoil: it was downward revisions to US GDP, raising fears of a double dip recession. This occurred against the background of looming default for Greece, revolution across the Arab world, the obliteration of part of Japan’s east coast – in short, a climate of absolute fear.

And let us not forget that at that time, the US federal budget deficit was running at 8% of GDP.

Today the situation is very different. Markets are behaving with relative equanimity because the infighting on Capitol Hill really isn’t as important as the economic fundamentals – unless Buffet’s point of extreme idiocy is breached, of course. Today, the federal deficit is 4%, and falling. US GDP growth has been increasing (and the last set of backdated revisions saw the numbers go up this time). Unemployment is 2% lower, bank balance sheets are cleaner, the housing market has picked up, manufacturing is stronger – and Europe, too, seems considerably further from the brink of catastrophe than it was two years ago.

A particularly gifted politician might be expected to assimilate all these things without even thinking, adapting instinctively to the changed national mood. It certainly appears that the President has done so. In 2011 he conceded ground to avoid a shutdown which was posing an additional threat to confidence. This time round there have been no concessions. In fact, Mr Obama has ruled out negotiating with his opponents at all until the government is reopened and the debt ceiling raised. “I’ll negotiate with you only after you give me what I want.” It’s an insouciant stance to say the least, and so far, the damp squib shutdown appears to justify it.

We ought not to be one-sided. The healthcare reform so vehemently opposed by many Republicans has been controversial from the start and unwieldy to implement. And without their intransigence back in 2011 that budget deficit would likely not have been repaired to the extent that it has. The US debt burden is huge, and such a position brings with it expense and vulnerability.

Nonetheless, the President is on the right side of the markets’ mood and the economic undercurrents this time – so long as he can avoid a sovereign default. At that point, CDS at 42bp would begin to look like something of a bargain …

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