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Washington is "Playing with Fire." What's Burning?

For six weeks stock markets have been going down steadily. But nobody seems to know exactly why.

One day the pundits talk about poor job numbers in the U.S.; another day they blame a so-called slowdown in China. Next day it's the Greek debt crisis. You name it, they blame it.

All of this incoherent chatter makes it pretty clear that no pundit really knows what's happening. They're making it up as they go along, hoping to put believable labels on trends they don't understand.

Investors need answers. Why is the Dow Jones Index in its longest continuous slump since 2002? Why are all of the global market indexes I review showing similar declines?

Bloomberg's latest report says "The market is still digesting that there's been a softening in economic growth in the U.S. and other parts of the world".

Dow Jones Index: Six Week Slide

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Well, for once, a picture is not worth a thousand words. This chart does not fully convey the fact that a trillion dollars has been wiped from the value of U.S. equities since the S&P 500's peak.

After its biggest rally in five decades, the S&P has lost 6.8 percent. So, is the world economy really slowing down that suddenly and that sharply? In a word, no.

The U.S. may be lagging some optimistic growth predictions, but American corporations, especially those that have multinational businesses are cash-rich and often sell at surprisingly cheap valuations. Emerging economies are still outpacing the U.S., with China, India, Brazil and Russia taking the lead. The market's move and global economic performance are not even closely matched.

Here's another issue that pundits have found difficult to explain. Market downturns in recent sessions have shown across-the-board declines. Few, if any industries are spared on a down day. This is not normal, but it has become typical in the market's current slide.

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This S&P heatmap from June 10th depicts a bloodbath in almost every sector. Only a few stocks, mainly in the banking sector, are spared due to a positive news development that day.

How is it that virtually no industry and very few companies escape this general decline? Let's look for reasons beyond the "usual suspects." Perhaps "past performance" isn't to blame this time. Perhaps the markets are anticipating future events as they so often do.

"Playing With Fire"

If you invest your time in watching American newscasts, you might come to believe that Congressman Anthony Weiner's Twitter account is important, possibly worthy of the lead position in the network newscasts of the most powerful nation in the world. But not if you are Chinese.

For the benefit of politicians and journalists who aren't paying attention, China holds approximately one trillion dollars with of American debt instruments. That makes them our banker. And that should give the Chinese a lot of say in how the U.S. conducts its economic affairs.

What are the Chinese thinking? Well, you can bet they don't care at all about Weiner. They're worried about their investments.

The United States is "playing with fire" as it toys with the idea of defaulting on its debt, according to a senior advisor to China's central bank. These remarks by Li Daokui are the sharpest ever to emerge from Beijing as the U.S. sovereign debt situation approaches a potential crisis.

What would be the result of a U.S. default? A presidential spokesman says the results would be "catastrophic".

Keep in mind that this potential catastrophe is only weeks away. Washington has set August 2nd as the deadline for Congress to raise America's debt ceiling. But lawmakers are making little progress on lifting that limit, mainly because Democrats and Republicans cannot agree on spending cuts to go along with the new debt ceiling.

This column is purely non-political, but it is important to report that the Chinese say they are most alarmed by a Republican proposal to allow a "technical" debt default in order to force Democrats to agree to their cost-cutting priorities.

As Reuters reported: "The idea of a technical default - essentially delaying interest payments for a few days - has gained backing from a growing number of mainstream Republicans who see it as a price worth paying if it forces the White House to slash spending."

Small wonder that the financial world is uneasy. China's Li warned, "The result will be very serious…I really worry about the risks of a U.S. debt default, which I think may lead to a decline in the dollar's value".

That National Australian Bank calls the prospect of default a "horrible" idea, with dire consequences for the world's economy.

Oman, which pegs its currency to the U.S. dollar along with most Gulf Arab states, says a U.S. debt default would destabilize Gulf Arab financial reserves.

We are talking about the potential for a global financial tremor…an event which would make the Greek bond default crisis look like child's play.

Don't Panic

A lot of U.S. politicians and pundits have called the prospect of a U.S. default on its debts "unthinkable" or "impossible". Yet the talks in Washington are making little progress, and time is running out.

Because stocks markets are forward-looking, it would be irrational if traders didn't include the risk of gridlock in Washington in their considerations.

Personally, I don't believe that either side of the debate will allow their partisanship to ruin the full faith and credit of the U.S. government. But there is a price to be paid for playing with fire.

Moody's and Standard & Poor's have already warned the U.S that its sterling credit rating could be at risk if it fails to raise its $14.3 trillion debt ceiling or fails to rein in its long-term deficits. Now the third major credit rating agency, Fitch, has joined the chorus of alarmed voices.

One Chinese credit agency says America is already in default. Dagong Global Credit Ratings of Beijing has declared that the United States has already defaulted by letting the U.S. dollar weaken.

It may not be time for a panicky rush to the exits, but it is a time for concern. A U.S. default is very unlikely. No one stands to gain from it. But endless partisan wrangling is bringing us closer to the edge than we should be. Markets are now measuring and putting a value to that risk.

It's high time for Washington politicians to start putting the good of the country and the stability of the world in first place. Playing chicken with debt default is, as the Chinese say, playing with fire.


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