Capital Markets Update

By Louis S. Barnes Friday, July 29, 2011

We interrupt this political soap opera for a brief message from reality.
The Treasury bond market is doing fine, the 10-year a new 2011 low, 2.85%. How could this be so, news media and officials chanting, "Default, default, DEFAULT..."?
Treasury bonds are doing fine because the United States will not default on them. The Treasury has quietly assured investors that interest will be paid on time, maturing debt paid by issuing new bonds under the limit. The cash required to do so is relatively trivial, perhaps $25 billion in August versus tax revenue near $170 billion.
However, short-term markets are stressed. If this soap opera falls apart altogether, tax revenue will fall short of other August spending commitments by $130 billion or so, which we otherwise would have maintained by borrowing. In August alone. Furloughing half the government for even a week or two would guarantee a new recession.
The Treasury market is fine for another reason: Europe is falling apart (again), their latest grand fix lasting less than a week. Spanish and Italian long-term bond yields are rising back to pre-crisis levels, both nations too big to save. Italy's debt is 120% of GDP, and at about 100% any country crosses the black hole threshold.
The Treasury market is fine for a third reason: even before this morning's weak GDP reports (Q2 growth 1.3%, personal spending only .1%; Q1 GDP revised down to just .4%) markets knew the US economy was is gently sinking. Forecasts for a better 2nd half of 2011... better hurry. June orders for durable goods slid 2.1%.
Treasurys are doing fine despite threats from newly pushy S&P to cut our AAA rating. Hell hath no fury like a rating agency scorned. The rating cut will be embarrassing, but little else. Ratings are useful for bond-issuers difficult to research: Burkina Faso, or new sewer bonds from West Frog Bottom. The entire financial world studies the US open book every day, and reality is what it is, not what S&P says.
Our debt situation is deteriorating, but unless you can find a better-grade issuer off-planet, your choices are limited. We owed $5 trillion in on-the-market debt in 2007, and owe $9.7 trillion now (the $14.5 trillion screeching from every channel includes intra-governmental bookkeeping). At something like a $1.3 trillion deficit each year forward, and a GDP maybe $13.3 trillion, we're less than three years from Italy.
Europe talks and talks and does nothing. Churchill dismissed them in the 1930s as having "All the collective security of a flock of sheep." Here, we yell and scream and fiddle and then DO things. It's not our style to sit while Italy-status draws near. Like climate forcing, structural loading, and straws on camels, the moment that our political system begins to spasm is unpredictable, but we tend to act in time.
The moment came last November, in the biggest switch in House power since 1948. Enough voters became worried about Italy-status to sweep into office a large majority of Republicans, 242 of 435; 87 freshmen, some sensible, many propeller-heads, each sworn a blood oath to balance the budget. That majority is now doing exactly what it was elected to do, a concept eluding the President and his party for nine months.
Now we have a first-class American riot. The new Republicans have arrived like a hatchet-swinging mob of temperance ladies in a saloon full of borrowing-spending addicts. No excuses accepted: "We can stop whenever we want! And -- EEK -- you can't cut us off while we have the shakes! We need to taper off. Leave us enough booze for a couple of years -- don't make us argue again soon. Takes the fun out of the hooch."
Mr. Obama might still break up the temperance mob this weekend by dropping his condescending how-dare-you and explain what a shut-down government would look like. That's what Willy did to Newt. Instead, this accusation that the temperance mob refuses to compromise just eggs them on. They think they have compromised: no demand for a balanced budget right now, they accept new revenue via tax reform, and they know that "$4 trillion over ten years" cuts the deficit by only one-third. They are using the debt limit to force cold turkey because they have no other means.
Their best service: to wake up the nation, and force it to learn and to participate.
The debt-to-the-penny ticker, with excellent historical tables and explanations: http://www.treasurydirect.gov/NP/BPDLogin?application=np

www.CalculatedRiskBlog.com 's splendid graph of today's GDP revisions. We have had some growth from bottom, but no recovery, and the growth we have had is flattening.