Equities, as well as the forex markets, are uneasy as we approach the day when the US Government might run out of money. Senator Harry Reid, the leader of that government body, says the credit agencies might issue a downgrade warning of US debt, as soon as this evening. Reid's statements are usually political posturing, an attempt to point blame at the only Republican controlled body should this evenings negotiations fail.
As we mentioned earlier, Republicans are alarmed at the rate of government growth under Obama. In January 2009 when he took office, the debt was $10.6T. It is now up to $16.7T. Under Obama, the Federal government debt is on a path to grow as much as the deficit did under all previous presidents combined.
Recently, the rate of government spending has slowed, the result of Democrat concessions during the last deficit debate. This is known as the sequester reduction, a percentage reduction in all spending. Democrats now want to void some of the previous reductions. This is not acceptable with the Republicans.
There is an abundance of criticism of the cumbersome political process. Christine Lagarde, the French lawyer who is now head of the IMF, had this warning:
"American lawmakers risk causing a 'massive disruption the world over' that could tip the global economy into another recession if politics gets in the way of raising the country's debt ceiling and the ongoing government shut-down remains unresolved, Christine Lagarde, the head of the International Monetary Fund, warned on Sunday as the US Senate became the focus of talks to end the budgetary deadlock in Washington."
The world may worry about a US sovereign default, something I do not think will happen, but there is another concern. According to the Keynesian theory, during a recession, government spending should make up for the shortfall in the private sector.
The Keynesians surrounding Obama proved hearty disciples of their leader. Their spending increased the US deficit from $10.6T to $16.7T in only five years. Truly a great effort, but where is the growth? Is this all there is? Maybe Keynes was wrong!
The government was not the only big spender. According to a recent CNBC article:
"As Washington is struggling with debt and all its political ramifications, American companies and consumers are embracing it, running up record amounts in 2013.
Whether it's corporate loans, all quality levels of bonds or simple consumer credit, the debt party is back on in the U.S., whether it's in the boardroom or the living room."
- Consumer credit of $3.04 trillion as of Q2, +22% over past three years
- Student loans +66% over past three years
- Total household debt is $13 trillion, almost back to 2007 peak
- Government debt almost $15 trillion
- Through September junk bond issuance is a record $372B, +27% y/y
- US loan volume is $1.53 trillion through Q3. +25% y/y
- Globally, syndicated marketed loans hit $2.93 trillion Q3, +15% annualized gain
- High-risk leveraged loans global volume hit $1.23 trillion, highest since 2007"
It looks, then, like we have a debt recovery, propelled by both the US government and the private sector. This should have given the US economy greater expansion. It has not. If the current 1.5%-2% is the best growth the US can achieve during a debt expansion period, what will happen if the Bernanke taper starts or the consumer gets spooked?
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Ms Lagarde can worry, if she chooses, about the global impact of the US economy should there be a US debt default. This is a low percentage bet in my opinion. More importantly, what is going to happen to the global economy when the US debt expansion slows?
Perhaps she should show more concern about the French economy, smothered by the Hollande government taking 60% of GDP.
Click to Enlarge EURUSD Weekly Forex Chart
The Tuesday-morning strength in the USD versus most currencies was in response to optimism for a settlement in Washington. Against the euro, the USD gained to 1.3480 before returning to the top side of 1.35. Eventually, there will be a Washington accord. The USD acts like it will strengthen when this happens.
Use strength in the euro and a return to 1.3550 to sell the euro versus the USD. Risk 100 pips with a target to the 1.34 handle.