Here's the newest edition of Stock World Weekly: Clowns to the left, Jokers to the right.
Our bearish outlook heading into this week proved accurate as U.S. equities traded sharply lower. We caught a glimpse of “No Mo POMO” in action. Not surprisingly, without POMO money from the Federal Reserve propping up stocks, the market behaved poorly. As Lee Adler of the Wall Street Examiner warned last week, “Normally, even with QE [quantitative easing], we’d expect some pressure to show up either in the stock or bond markets around such a large settlement. It should be a lot more ‘interesting’ without QE. This will be the first real test of the market without it since last August.” (Stock World Weekly, July 10, p.11)
Europe is facing its own challenges. The European Debt Crisis of the Twenty-first Century, “The Black Debt,” continued spreading across Europe like the plague. (Originating in China, the Black Death swept through Europe from 1348 to 1350, killing 30% to 60% of the population.) Our modern era’s fiscal contagion may be less lethal, but it still threatens to tear apart the economic fabric of the Eurozone by unraveling a complex arrangement of debt owed between member nations and eroding confidence in the continued viability of the Euro as a currency. The magnitude of the collateral damage to other countries is not known, but given the black box nature of the derivatives market, it is likely substantial. (See e.g. Derivatives Cloud the Possible Fallout From a Greek Default)
As the clock ticks down to the impending August 2 deadline for lifting the debt ceiling, negotiations between the White House and Capitol Hill are growing increasingly tense. Lawmakers and the President attempt to arrive at a compromise that will inevitably satisfy no one. President Obama, pushing for a combination of spending cuts and tax increases, reached out to the American public during his weekly radio and Internet address, declaring, “We have to ask everyone to play their part because we are all part of the same country. We are all in this together.” (Congress seeks debt solution, Obama goes to public)
Obama has embraced some measures that members of his own party deeply oppose, including proposed reforms to Medicare, while the Republican opposition has taken a hard line against any tax increases. Portraying the crisis as being a result of Washington’s political culture, Republican Senator Orrin Hatch opined, “Washington has consistently demonstrated that it cannot control its urge to spend.” (Debt limit crisis: what’s happening today) Will Hutton at the Guardian writes, “For months, Republicans have used their new majority in the House of Representatives to block any move to lift the artificial cap on the amount the US government can borrow. If by this Friday they still refuse – insisting on up to $4 trillion of spending cuts, excluding defense, and no tax increases as the price of their support – then the US will be unable to service its public debts. The biggest economy on Earth will default...
“But the Democrats cannot agree to the Republicans' absolutist demands, in part because the arithmetic of deficit reduction does not work without tax increases and cuts in defense spending, in part because they passionately believe that with taxes the lowest for 50 years, the US's rich should share in the pain and in part because in any human exchange there is an element of horse-trading.” (What hope is there for us if America is driven to the brink of meltdown?)
Financial economist and historian Dr. Michael Hudson was recently interviewed by Bonnie Faulkner on Guns N Butter. When Ms. Faulkner asked his opinion of where the U.S. economy is headed, Mr. Hudson replied,
“The economy’s going under because Wall Street and investors realize that it’s a done deal. That Mr. Obama is going to succeed in pushing the economy much further into a depression. We need the depression in order to cut living standards and labor by 30 percent. We need a depression in order just to lower the wages of America and to have an excuse – of course, a depression is going to make the budget deficit even larger and the solution to the depression has already been written up, just like the invasion of Iraq was all written up before 9/11, the solution is going to be that the government is going to sell off its land, whatever is in the public domain.
“The American government is going to look just like Greece and just like Ireland. They’re going to be told, ‘The states can’t pay, there’s no federal revenue to share with Minnesota or Wisconsin or the city of Chicago. They’re going to have to sell off their roads, sell off their streets, sell off their infrastructure, sell off their public utilities, sell off their business. The government will sell whatever it has, the Postal Service, to essentially buyers who will now borrow the money from the banks making a huge new market for banks and investment bankers, in privatizing and cutting up what used to be the public domain and turning it over to the wealthiest 10 percent of the economy. So people realize yes, the class war’s back in business. We’re going into a depression. We’ll buy back all these stocks after they go but meanwhile, the game’s over. Let’s grab what we can and just bail out. And that’s what’s happening now.”
Ms. Faulkner: “What is your assessment over the current debate in Washington concerning the raising of the debt ceiling? This debate seems to be taking place between the Obama administration and the Republicans without much input from Democrats.”
Mr. Hudson: “It’s a good cop-bad cop deal, a charade that they’re both playing. The Republicans are playing the role of the bad cop, saying, ‘You have to not raise taxes on anybody, no progressive income tax at all, no closing of the tax loopholes, not even a prosecution for income tax fraud. And by the way, we can get a lot of money if we just give a tax holiday to all of the companies and the individuals that have been keeping their money offshore. Let’s just free wealthy people from taxes altogether and that will help recovery.’ So they’re being sort of the bad cop so Obama can pretend to be the good cop and say, ‘Hey, boys, let me at least do something. You know, I’m willing to cut back Social Security, I’m willing to take over really what was a George Bush program, but you have to let me get a little bit of revenue somewhere.’ And at the very end the Republicans will say, ‘Oh, okay, you can throw us into the briar patch.’, and they’ll give something and they’ll essentially get their program and Obama will have sold out his constituency.”
Ms. Faulkner: Would a U.S. default send interests rate soaring and if so, what would be the economic effect?
Mr. Hudson: “An interest rate wouldn’t matter if you default. I mean, if you tell me I can write you an IOU but you’re not going to collect, I’ll give you 20 percent. What does it matter if you default? No, it wouldn’t send interest rates soaring at all. It wouldn’t have any effect at all. This is all a just pretend argument to create the crisis to give Mr. Obama the opportunity to do what politicians do – to sell out his constituency to his campaign contributors on Wall Street. He’s going to go down as a Herbert Hoover, or rather a Warren Harding probably. He’s going to go down as the man who brought on the depression that the Republicans never could have gotten away with. Only a Democrat posing as a left-winger could support the anti-labor, anti-wage, pro-Wall Street policies that his advisors have been pressing. And there again, that came out in the New York Times interview with Sheila Bair.”
Ms. Faulkner: I see. So this is a charade put on for public consumption, the business of a possible debt default.
Mr. Hudson: “It is to create the illusion of a crisis. No politician or Wall Street really likes a crisis but what they do like is the illusion of a crisis to create a pretense for introducing a solution to the crisis that actually makes fortunes for them all. And the way in which Obama resolves the non-crisis of the budget limit is going to make fortunes for Wall Street – and impoverish the population for the next decade.”
Ms. Faulkner: So this is a way of getting away with all of this?
(Read full interview here: Wall Street’s Euthanasia of Industry)
In spite of all the tension, drama and political posturing on Capitol Hill, we currently believe that some kind of a deal will be worked out prior to August 2, and that it is highly unlikely that the U.S. will actually default on its debt obligations. We remain moderately bullish on stocks for the long term, but bearish in the near term. Consequently, we are more likely to look for bearish trade ideas than bullish trade ideas early next week.
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There’s a video from the movie Reservior Dogs that goes with the title, thanks to Rob for pointing it out. (Embedding disabled, but click here.)