Thursday, July 21, 2011

Quality of Political Leadership

The debate over raising the debt limit in the United States has been interesting to me, because two thinkers who I have a great deal of respect for took diametrically opposed viewpoints.  On the one hand, Calculated Risk has been adamant that it was all a bunch of political theater and the debt ceiling would be raised in time.
Congress will probably push this to the brink, but they will raise the debt ceiling before the country defaults. The first rule for most politicians is to get re-elected, and the easiest way to guarantee losing in 2012 is to throw the country back into recession. If that happened, I believe the voters would correctly blame the leaders of Congress, and I think Congress knows that too. Therefore it won't happen. I'm not worried and neither are investors.
On the other hand, Bruce Bartlett has been warning for months that, no, in fact the Republican congress was quite capable of failing to raise the debt limit:
It's never happened before. And I think many people in financial markets, and perhaps even in Washington, just assume away the possibility. They cannot conceive of the insanity of allowing the debt to default. But what I keep trying to explain to people is that these Tea Party people really are that crazy. And I'm just trying to get people to believe me.
Watching the daily news flow, it increasingly seems that the Bartlett view is closer to the truth.  A bipartisan group of senators is working on a compromise, but there seems to be no sense that House Republicans are likely to go for it.  Kevin Drum suggests a hybrid view - that Republicans are crazy enough to trigger a default on government obligations, markets will go nuts once they realize this, and then Republicans will panic and fold (much like happened with the vote to approve the TARP plan during the 2008 financial crisis).
For now, I'm going to stick with my guess that we'll blow by the August 2nd deadline, markets will go nuts, and we'll end up with some kind of debt ceiling increase by August 7th. We'll see.
That seems as good a guess as any.  At any rate, it doesn't seem that an agreement acceptable to all the power-centers is particularly close and it's less than two weeks to August 2nd.  So it seems likely that this will have to get significantly worse before it gets better.  And that seems likely to leave some lasting stain on the financial reputation of the US, which in turn will lead to higher interest rates for a long time.  It should leave a lasting stain: if the US is apt to elect a faction to power who are not responsible enough to ensure that the government meets all its obligations, then clearly the United States government is not a very reliable financial entity.  Higher interest rates on US government debt will push up interest rates on corporate and household debt, which, of course, will tend to slow the economy further.

Speaking of things that seem likely to get worse before they get better, the latest news out of Europe seems little better.  German leader Angela Merkel seems determined that any plan should involve a default on Greek bonds.  That in turn will render Greek banks insolvent, which will render them unable to operate without extensive help from the ECB, which it is so far not agreeing to provide.  Furthermore, if Greek bonds default in some manner, that can do nothing but increase the cost of borrowing for all other weak members of the European periphery.

At heart, the issue seems to be that the EU leadership has no plausible approach to the basic contradictions of the Eurozone.  European monetary policy is being run in a way that is helpful to Germany, and completely unhelpful to the deeply depressed peripheral countries, and fiscal transfers on any scale seem to be out of the question.   This means that the peripheral countries really have no reason to be in the Eurozone, and unless major structural changes are made, it seems likely that they will not be able to stay in the Eurozone.  Meanwhile, at every stage, the leaders of key Eurozone countries are doing the absolute bare minimum required to stave off immediate disaster, while doing nothing to address the fundamental problem, which thus gets worse and worse.  Assuming the leadership continues to operate in this way, it seems likely that we will continue to get more and more of the same sort of results.

On both sides of the Atlantic, these issues seem to have considerable potential to worsen to the point that they affect the real economy.  If so, the oil price spike of 2010/2011 will be over, and resource issues will continue their retreat to the back of the business section of the newspaper.  Only for a little while, however.  The inexorable motorization of the developing world will continue, lower oil prices will cause delays in drilling and new supply projects, and the conditions for the next price spike will be put in place.    And meanwhile, progress on converting away from oil will continue to move at a glacial pace.

11 comments:

Alexander Ac said...

Debt ceiling will be raised, I think it is 99 % certainty...

regarding the last sentence - there is no technological solution to the exponential growth...

cheers,

Alex

Alexander Ac said...

Zero Hedge has interesting article:

S&P Says Likelihood US Is Downgraded To AA As Soon As Early August Is 50-50

" As for S&P: please explain to US how 120% debt/GDP is better than 100% debt/GDP, and thus more worthy of a AAA rating? Please. Because we must be bloody stupid."

Indeed.

Does S&P suggest that the debt will be repaid in the future? Another industrial revolution anyone???

James said...

I have a theory about sovereign debt - you don't have to be faster than the bear, you just have to be faster than the other campers.

In other words, I think that a technical default on US debt won't push up interest rates right away because there are weaker slower campers currently being chased by the bond vigilantes (the PiiGs).

[This is not logical of course, but I agree with George Soros thesis in The Alchemy of Finance about why markets are not logical.]

But 10 to 20 years from now when the US is the slowest/weakest camper running from the bear, everyone will remember that the US defaulted in 2011, and the US government will suffer a faster loss of confidence then than it would have otherwise.

Mason Inman said...

I'm curious what it is you respect about Bruce Bartlett as a thinker. He takes the abiotic theory of oil production seriously, and argues that there's plenty of oil available.

(See his 2005 Washington Times article: http://www.washingtontimes.com/news/2004/jun/8/20040608-092733-4642r/)

From what I've seen, Bartlett has taken this kind of approach for decades.

Burk Braun said...

It isn't really "thinkers" who are the ones to ask here. We are dealing with insane people who A- Don't know anything about economics, B- Don't want the economy to improve for political reasons, and C- Don't even want the government to function at all, for ideological reasons.

The betting of the "thinkers" is all about whether Wall Street will bend its politicians to deal with reality before they lose a bunch of money, or not. As far as the politics, as usual, the power in any political negotiation goes to the crazier party. So here we are, as hostages.

What Obama should have done is to refuse to negotiate from the start- to say that as far as he was concerned, the ceiling was, as the constitution says, non-negotiable, and if congress wanted to shut the government down, it would be on their backs.

Kostas Kalevras said...

The debt interest rates are more or less set by the Fed long term rate policy in cooperation with the primary dealers.

As for the debt limit, there's a nice idea about using coin seigniorage http://pragcap.com/coin-seigniorage-a-legal-alternative-to-the-debt-ceiling

kjmclark said...

Wow! Bruce Bartlett wrote that?!? The rest of his stuff seems so reasonable. Guess I'll have to have my salt-shaker ready when I read his comments from now on.

Going on a week & half trip into the backcountry next week. Might be more interesting than I thought when we come back...

nick said...

Burk, he should have done that, but he wanted entitlement cuts too badly.

sofistek said...

"if the US is apt to elect a faction to power who are not responsible enough to ensure that the government meets all its obligations"

I'm not quite sure what you're saying here. Is it that responsibility means ensuring that debt, already unrepayable, is increased? Unfortunately, whichever way this goes, the decision will be irresponsible.

Greg said...

"And meanwhile, progress on converting away from oil will continue to move at a glacial pace."

This is a good line to finish on. Investment slows in hard times, and conversion requires investment. The risks from peak oil and from climate change just increased.

Rhisiart Gwilym said...

Stuart, what you predict in your last paragraph tallies closely with John Michael Greer's assessment of the pattern of the nearer future: stepwise down-lurches in economic activity, with respites between, often with anaemic little re-starts of growth which promptly trigger the next down-lurch.

The overall trend is an inexorable movement away from industrial hitech societies, and towards a global decomplexification, as described in Tainter's 'Collapse of Complex Societies'.

I can see literally nothing, anywhere on the horizon, which could counter that process.