Debt Ceiling Talk Collapse Would Be a Great Thing

by: Bo Peng

Ever since the '08 crisis, we've been bombarded with constant warnings of catastrophic consequences if we don't give free money to everyone. In fact, I suspect it's become too widely adopted to be any good any more: If I don't get what I want, there'd be catastrophic consequences. Funny that some people had been warning of catastrophic consequences about free mortgages and systemic risks for years before '08 and the same clowns had been denying them with equal authority and confidence, catastrophically.

Furthermore, the same clowns got everything they asked for over the past three years, promising to fix the problems, and failed to fix the problems with impeccable consistency. And don't get me started on rating agencies. If they were any good, where had they been before '08? So I think I should be forgiven for a little catastrophe fatigue. I think a debt ceiling talk breakdown, along with the ensuing technical default of the treasuries and the likely downgrade of US credit, would be the best thing that ever happened to us since at least the crisis.

First, it would show the world that some in the US government are actually serious about controlling deficit. It would be a huge boost to the long-term outlook of US credit, the dollar, and treasuries. Sure, there might be some "transitory" chaos in treasuries, due to hardcoded restrictions, collateral requirements, money market idiosyncrasies and panic, but it's a certainty that it's only a delay, with missed payments made as soon as they figure out some compromise. In other words, the default is only transitory.

Would the equities market collapse? It shouldn't. Corporate equity valuation has little fundamental linkage with such a temporary, technical delay of treasury payments. But there might be some wild swings as opposing forces, both psychological and real, battle to sort out which way we'd like to go.

Would gold rocket? It shouldn't. This is not a terminal event. It has zero practical impact on anyone not counting on treasuries coupon payment of the day to buy Big Macs. Again, silliness might reign for awhile and it should be fun to watch from the sidewalk of long volatility.

Would treasuries tank? They shouldn't. But here temporary technicalities may matter more in the immediate term, especially on a downgrade. Would it trigger a CDS settlement? How would various funds, especially money market funds, deal with it? How would the vast ocean of treasuries collaterals be treated? Would the repo market be thrown into mayhem? I don't even want to think about it. But the bottom line is all these matter more to financials (including manufacturers such as GE, GM, and Boeing (NYSE:BA), of course) than anybody else. And financials are fine. TBTF, remember? I'd be watching, waiting for it to calm down a bit, and load up on some of the hot-out-of-the-oven defaulted paper. No, not for long, of course. No self-respecting person would do that. Just for the short-term.

Would the dollar be flushed after use? It shouldn't. This is one thing I think would go up even in the immediate term. Everybody would want to grab some dollars, even if grudgingly, in this scenario. Optimists would cheer for the brighter future for the US and the dollar. Pessimists would go risk-off and long the dollar. Even if you believe treasuries would tank, you'd still have a hard time explaining why the dollar should follow.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

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