Things Look So Bad They Can Only Get Better

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 |  Includes: TRSY
by: Calafia Beach Pundit

To judge by the level of Treasury yields, the outlook for the U.S. economy has never been so bad. At 0.2% and 0.9%, respectively, 2- and 5-yr Treasury yields are lower today than they have been at any time during my lifetime. Far lower. Lower even than they were at the end of 2008, when the market was priced to years of deflation, a global depression, the default of as many as half the companies in the country within the next 5 years, and a global financial collapse. Wow.

The only thing that makes sense of these extremely gloom-and-doom yields that we are witnessing today is that the market is pricing in a massive default of European sovereign debt that in turn would result in the collapse of the Eurozone banking industry, and such an implosion might bring down the entire global economy. In other words, we have a market that is essentially priced to an end-of-the-world-as-we-know-it scenario.

In order to reach this grimmest of all possible scenarios, the market is making the dangerous assumption that all the bad things going on are going to get much worse: that Obama and the Democrats are never going to triangulate to a real pro-jobs program, that the Fed is going to print us into oblivion, that the economy is headed straight down, that the PIIGS are never going to veer from their big-spending, big-borrowing path, and that Europe is going to eventually implode.

Can things really be this bad and get even worse? Is there no hope for a turn to the better? Yesterday I read an amazing policy piece put out by the progressive think tank Third Way. In it they propose sweeping tax reforms, most of which make perfect sense, and if implemented would very likely usher in a new wave of economic growth and renewal. Art Laffer might have ghost-written most of the piece for all I know. It's a stunning contribution to good public policy, especially coming from the Left. Today Obama bowed to the reality of a weak economy and asked the EPA to withdraw its new stringent air-quality standards. Ireland has already opted to slash spending; maybe the Greeks will figure out that they have no other choice.

With his popularity plunging, and the economy on the ropes, Obama is being forced to change. I can't imagine that he will not adapt further, eventually supporting pro-growth, pro-business policies. The electorate doesn't like what's been happening. Keynesian stimulus policies have been proven not to work, and next week he simply can't reiterate his calls for more stimulus spending and more unemployment benefits. I've never seen so much political, economic and financial tension in the markets. This is not a long-run equilibrium situation; something has to change for the better, and it can't wait until next year's elections.