The Market is down all six of the last six trading days, the S&P looks to be headed for a bounce today, but is this something to cheer or just an oversold bounce?
The reason for this slaughter-fest? Continued lies by governments — specifically, those in Europe.
The “big lie” of the season (and year) is the same one we’ve run in the United States for more than 30 years: We can spend more than we take in and it will be ok.
Now to be fair when you get away with lying for 30 years, it’s hard to argue that your strategy is not “successful”, at least in the short term. Given our propensity to live “in the today” and focus only on the short term, it should not surprise that this type of magical thinking pervades not only the United States but Europe as well.
Even the so-called “Conservatives” who put forward shams such as “Cut, Cap and Balance” don’t really mean it. One such example is found in one of the appropriations bills in the Senate claimed to have a $1 billion “cut” in spending which Senator Sessions contends is actually a $9.4 billion increase – none of which is “counted” as it’s all in “mandatory” spending (even though such “mandatory” spending still must be, under the Constitution, passed each year!)
Of late our Treasury Bill funding costs have benefited mightily from fear that Europe is about to break apart into feudalism or worse, perhaps spark a war. After all, Germany’s insistence on being able to “review” or even veto other nation’s budgets is tantamount to a central government — centered in Berlin, of course. We tried that twice before, I think, in the early and mid 1900s — I wonder if anyone remembers how it turned out?
Why is this strum and furor going on over there? Simple: Budget deficits are unsustainable over the intermediate and longer term — always. Eventually investors refuse to continue to fund that which the politicians refuse to pay back and revolt, leaving the nation with only two options: Cut the deficit spending or attempt to force the entire population to fund the previous deficits by depreciating the currency.
Here’s the problem with the second path, which everyone seems to think (other than bond buyers) the US will choose: Bond buyers don’t intentionally lose money either, and this will force yields higher – a lot. See the 1980s for “how much”, which in turn makes rollover of the existing debt impossible.
If you see the same thing that is happening in Europe in this outcome, you’re right – it is the same outcome and it’s ugly.
Ultimately the risk of rollover moves from weak hands to strong ones, until there are no more strong hands. Then the facts must be faced. Japan, which has siphoned off the savings of their people for two decades has now backed themselves into a corner to the point that a mere two percent increase in their interest rates drives their debt service costs above all tax revenue — the point of not just technical bankruptcy but actual bankruptcy as such would force an instantaneous shutdown of all government functions!
Is this some sort of doom-mongering nonsense? Uh, no. Remember that Italy has a primary surplus — that is, ex borrowing costs (interest) and deferred expenses (e.g. promises to retirees) they are taking in more in taxes than they are spending. That doesn’t matter — the market has surmised that these deferred promises and interest expenses are going to go up, not down, and thus the primary surplus is an invalid measurement of fiscal health — they want an actual cash-accounting surplus and since there isn’t one, bond yields are going up — fast.
That in turn forces the actual budget picture the wrong way even in the face of the alleged primary surplus. There is no escape from such a hole other than to cut spending to the point that you have an actual cash market surplus — then instead of rolling over debt at an unattractive interest rate you pay the maturing bonds and tell the market to go stick it.
That is the only means of dealing with such a situation when all is said and done. All the strum and furor sounds nice, but it’s not reality. You can bludgeon and bloviate but in the end analysis if you are selling something in the market it only trades at a price where there is both a willing seller and a willing buyer, and now the buyers are demanding more interest or they’re not going to purchase — period.
This lesson has been completely lost on the United States Congress, which continues to scream like a petulant child that “we’re #1” and “we’re different!”
No we’re not. We’re simply last, having the deepest treasury market. But that depth is not infinite and the shift of risk to us will eventually force the United States into the same box that Europe is in now — stop the deficit spending or else.
The wise policy would be to stop the deficit spending on our own before the market forces the issue. Contrary to popular belief we can do it, but the requirement to slay sacred cows — especially in the entitlement area — is politically difficult. Nonetheless a forced slash-and-burn budget fest rather than doing it on our own terms will be far more disruptive and this day, if we do not deal with the problems now, is coming and much sooner than most expect.