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Debt Deal, Downgrade, Doom, Gloom, and Etc.
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(August 8, 2011) If you missed last week (as we did), the best that can be said is that it was not pretty. True to form, gold gained during the chaos, silver hung in there pretty well, while the grey metals (platinum and palladium) took it pretty hard.
First, the gloom.

On Friday 8/5, AP quoted Ethan Harris, Bank of America’s chief economist, as he summed up what was signaled to the world by all the all the wrangling and infighting that preceded the closing of the US debt ceiling deal:

“The whole debate over the debt ceiling sent four negative messages to the markets: that we have a big debt problem, that we can’t fix it because we have a dysfunctional political system, that it’s okay to use the threat of default to achieve political ends, and that there’s no safety net if the economy goes into recession because we’re not going to have any more fiscal stimulus.”

If you were away on vacation you might not have gotten this news: last week US equities as represented by the Dow lost some 5.75% of their value in five days. Thursday’s loss of 4.3% was the single worst performance in one market session since 2008.

The next day, with what could be called unusual if not questionable timing, one of the big three credit rating companies, Standard & Poor’s, announced that it was downgrading US Treasury debt from its AAA credit rating to AA+. We were away on vacation when all this happened, so certainly it’s possible that you could get a more accurate picture from those who were actually paying attention at the time, but it seems that all hell broke loose.

Treasury officials protested, we are told, claiming to have found a $2.1 trillion mistake in S & P.’s figures. S&P answered to the effect of, well, at second look, you’re right, but so what? Even if we’re off a couple of trillion, the “political risk and underlying debt burden” justify this “modest” change in the credit-worthiness of the United States of America.

A statement on the Standard & Poor’s website dated August 5, 2011 reads:

”The downgrade reflects our opinion that the fiscal consolidation plan that Congress and the Administration recently agreed to falls short of what, in our view, would be necessary to stabilize the government's medium-term debt dynamics.

Remember, it was S&P and other rating agencies who, for much of the first part of the 21st century, assigned the coveted AAA rating to hundreds of billions of dollars worth of mortgage bonds that later failed rather dramatically. These bonds consisted of individual residential mortgages that were bundled up and sold to investors in the US and all over the world as “AAA” quality. The opinion of the rating agencies then was that much of that financial dreck was as creditworthy as US Treasury bonds. The lesson being, everyone’s got an opinion. So, yes, the week just passed seemed to bring nothing but bad news, both here and abroad. Not surprisingly, gold reached new record levels, trading over $1685 on Thursday 8/4, a $200 jump since July 1st, which translates to a gain of more than 13.75% in a mere 25 trading days.

Stocks feel following the patchwork fix on the debt ceiling, and the story now being told is that the market seems surprised by growing evidence of what is myopically categorized as a ‘potential double-dip recession.’

Of course, to anyone out there actually tracking consumer spending (outside of the showrooms of Gucci, Sotheby’s, Mercedes, etc) and the general paucity of ready funds in the hands of what used to be called the middle class, the pronounced ‘end’ of the recession a year or so ago was only statistical wordplay, at best. Times are tough out there. For most Americans, things haven’t been so good economically since the year 2007 or so. Yet we’re not in the crisis stage that seems to have struck much of Europe. Or at least, our citizenry has not yet taken to the streets in violent protest over government economic policies.

Yes, it was terrible week. The debt ceiling deal, which puts off the inevitable for another year, seems too little, too timid, and too late. It addresses none of the big spending and revenue issues, beyond the promise that a soon-to-be-created bipartisan Congressional panel (players to be named later) will take up this fight again, at some unannounced date in the future.

The easy, glib reaction to that prospect would be, oh boy, can’t wait to see that again. But, as the smoke from this ugly and unsettling battle clears away, at least it can be said that the issue of massive and perpetual over-borrowing by our government is now clearly on the table.

As David B. Rivkin Jr. and Lee A. Casey wrote in a column “A Debt Deal The Founders Could Love” on Tuesday’s 8/2/11 Wall Street Journal editorial page that what the White House called a “spectacle” and “three-ring circus,” (and Standard & Poor’s called a “debacle”) may simply be the people’s business being done as it always has:

“Our messy political system is working exactly the way our Founders intended it to.” …“Rarely in our system do the participants, whether in the House, Senate or White House, achieve all or even most of their goals in a single political battle. Sunday night, a debt- ceiling deal was reached that will raise the federal debt ceiling and permit continued borrowing to fund federal government operations through 2012. The hard questions – taxes and spending cuts - have been postponed. But the key point has been made. Few can now suggest that we can continue on our current spending binge. That is the beginning of a consensus, and a good start towards genuine change.”

Postponing the difficult questions also means that the electorate can have its say in the 2012 elections, and represent significant political risks for all parties. The Framers would be please at the “spectacle.””

In the wake of last week’s chaos, it would do us all good to take to heart that calm and reasonably optimistic outlook.

 

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