Monthly Archives: July 2011

Insurance Cost Against US Default Hits Record

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Somewhat misleading headline.

It reflects the odds of being able to deliver a specific treasury bond to the insurer at par.

Insurance cost?against US default hits record

By Michael Mackenzie and Nicole Bullock

May 25 (FT) —Insurance Cost Against US Default Hits Record
Published: Wednesday, 27 Jul 2011 | 10:14 PM ETText Size
By: Michael Mackenzie and Nicole Bullock in New York

The cost of buying insurance against a default by the U.S. rose to a record on Wednesday, in a sign of growing unease that gridlock in Washington over raising the federal debt ceiling may result in the Treasury failing to pay interest to bondholders.

In a CDS, a buyer of protection is compensated by the seller should there be a default or missed payment, known as a “credit event”. Premiums for one-year U.S. sovereign CDS rose sharply this week and traded at about 90 basis points in London on Wednesday, overtaking the previous high set in March 2009.

In the event of a U.S. credit event, the buyers of CDS would locate the February 2039 Treasury bond, currently priced at less than $88, and deliver that to the writers of insurance and receive $100 back, or par.

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Agents already anticipating lost income from looming spending cuts

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MBA Mortgage applications decreased last week: The Market Composite Index decreased 5.0%, The Refinance Index decreased 5.5%, and the Purchase Index decreased 3.8%. The refinance share decreased to 69.6% from 70.1, and the ARM share increased to 6.1% from 5.8%. The average 30-year rate increased to 4.57% from 4.54% and the average 15-year rate increased to 3.67% from 3.66%.

Durable Good Orders decreased 2.1% in June to a seasonally adjusted $191.98 billion, led by a 8.5% decrease in transportation equipment. Orders excluding volatile transportation equipment increased 0.1% after a 0.7% gain.
Federal Reserve Bank of Chicago Manufacturing Index was down 0.1% in June to 84.0 from May as higher steel and machinery production partially countered a decline among auto makers.

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Why there is a deficit

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The main reason we have a large budget deficit is because of all the tax advantaged savings plans- pension funds, IRA’s, insurance and corporate reserve.

All of these financial assets, which compound continuously, represent unspent income.

And unless they are offset by some other agent spending that much more than his income, the dollars won’t be there to be saved in these tax advantaged entities.

And also realize this is an accounting identity, beyond dispute.
Like 1+1=2.
Like how your checkbook must balance or you made an arithmetic mistake.

It works like this:

People work to produce and sell goods and services and someone get the dollars from all those sales.
Those dollars that came from the sales are exactly the amount needed to buy those things in the first place.
If anyone doesn’t spend the dollars he gets from the sales, there isn’t enough spending for the sales to happen in the first place.

So when a large chunk of our dollars that we get paid from wages and profits go into pension funds,
and don’t get spent,
all the things for sale can’t get sold unless someone spends that much more than his income.

And if we (both residents and non residents) don’t want to- or can’t- spend more dollars than our dollar incomes by borrowing dollars to spend,
sales fall short,
so income and jobs are lost in a downward spiral,
that doesn’t end until someone finally fills that spending gap by spending more than his income
to replace the spending power lost when earned dollars go into pension funds.

That’s where the government comes in.
When those dollars piling up in pension funds cause spending to fall short,
government can spend more than its income to make up for that lost spending power, fill the spending gap, and keep everyone working and producing and selling real goods and services.

So right now the high unemployment and low sales tell us there is still a big spending gap to fill.
In the past, this spending gap might have been filled by people borrowing to spend on houses and cars and all that.
But this time around people aren’t willing or able to fill the spending gap.
The current level of government spending that exceeds taxes (deficit spending) is only partially filling the current spending gap.
It’s a big economy and pension funds and corporate reserves are huge and growing,
which means the spending gap is huge and growing
which means the amount government spends that’s more than it taxes (government deficit spending)
is still too small to fill the spending gap.

the answer is quite simple- cut taxes and/or increase government spending until output and employment is restored and the spending gap is filled.

Unfortunately our fearless leaders have a large gap between their ears, and have it all backwards, and we’re all paying the price.

And it will get a lot worse if they keep cutting the government deficit and make the spending gap wider instead of narrower.

(as always, feel free to distribute and re post)

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“Sometimes nothing is a real cool hand”

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Perhaps the chilling reason no bill is even beginning to emerge from Congress is raising its ugly head. Could it be that members of Congress and the President, deep down, want to see the US government go cold turkey to a balanced budget? Like taking away the drugs from an addict, might they all believe it’s for our own good and our children’s future to take away the government’s credit card now, before it’s too late?

We know they all believe that because of the deficit we are on the verge of a Greek like financial crisis. We know they all believe we need deficit reduction to prevent catastrophe. We know they all believe the government has been borrowing from China to spend like a drunken sailor, leaving the debt to our grandchildren. We know they all believe we either make the tough choices now, or soon face the undeniable consequences. And we know they all believe that even the most aggressive packages under consideration won’t be sufficient to solve the problem.

So what’s a patriotic politician to do? What solves the problem and, while there will be near term pain, minimizes the total long term pain? Yes, running out the clock and doing nothing, which is exactly what’s happening. And all the while trying to make sure your opposition gets the blame for the initial pain, while positioning yourself to take credit for the good that will surely follow. Is that not what’s happening?

They are dead wrong, of course, and, consequently, we’re all dead ducks, as the price of nothing is far higher than anything I’ve seen discussed anywhere. With the automatic fiscal stabilizers disabled (Treasury spending can’t increase in a slowdown, and in fact is forced to decrease as revenues fall) the downward acceleration of the economy from the sudden cut in government spending will be far more severe than anyone has begun to imagine. The lack of general concern for what might happen is directly evidenced by the current market complacency, allowing those properly alarmed to get their hedges in place at very attractive prices.

…

What happens in the do nothing scenario?
Stocks go down globally, the US dollar goes up, commodities go down, US Treasury rates fall, credit sensitive interest rates rise, sales and GDP fall, unemployment rises, all in the context of a general global deflationary spiral.

So continue to hope for the best while being prepared for the worst.

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Profits and wages

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Couple of things.

First, corporations currently have low propensities to spend their income, so this means we need a deficit that much larger than otherwise.

Second, this goes back to the ‘labor market’ not being what’s called a ‘fair game’.
That’s because people have to work to eat, while business only hires if it can make a desired rate of profit. So game theory tells us that real wages will stagnate without some form of external support:

Economists at Northeastern University have found that the current economic recovery in the United States has been unusually skewed in favor of corporate profits and against increased wages for workers.

 
In their newly released study, the Northeastern economists found that since the recovery began in June 2009 following a deep 18-month recession, “corporate profits captured 88 percent of the growth in real national income while aggregate wages and salaries accounted for only slightly more than 1 percent” of that growth. The study, “The ‘Jobless and Wageless Recovery’ From the Great Recession of 2007- 2009,” said it was “unprecedented” for American workers to receive such a tiny share of national income growth during a recovery.

http://economix.blogs.nytimes.com/2011/06/30/the-wageless-profitable-recovery/

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Pelosi joins tea party

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Pelosi Statement on Proposals to Reduce the Deficit, Avoid Default

Washington, D.C. – Democratic Leader Nancy Pelosi released the following statement on proposals announced today to reduce the deficit and avoid default:

“It is clear we must enter an era of austerity; to reduce the deficit through shared sacrifice.

“The President has called for a ‘grand bargain,’ which provides long-term deficit reduction based on shared values and sends a message of confidence to the markets.

“The latest proposal from the House Republicans is a short-term plan that burdens the middle class and seniors, and continues this debate about whether we will default in a few months from now.

“Senator Reid has put forward a responsible plan to reduce the deficit that protects the middle class, and Medicare, Social Security and Medicare beneficiaries. It also includes many proposals already supported by Republicans.

“We must come together for an agreement because our economy and middle class will suffer from a default.”

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Treasury default requires reprogramming

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In case anyone thinks spending is operationally revenue constrained. Unless they reprogram the computers, the Treasury will routinely make all payments on a timely basis. And those payments create ‘real dollars’ in private bank accounts that can be spent regardless of tax revenues, and without borrowing from the likes of China.

And tonight’s speeches seemed to me confirmation of a power move by the Speaker of the House. He announced that on Wed the house will pass a modified bill that the Senate will also pass and send to the President’s desk for signature. If he succeeds, he will emerge as the leader who, from now on, will be the one to organize and have bills introduced and passed by both Houses. And on the odd chance that the economy improves, he’s positioned himself to be the Republican candidate for President.

“Steve McMillin, a former deputy director of the White House Office of Management and Budget under Bush, said Treasury has options but most of them are “pretty ugly.”

If Treasury were to decide to delay payments, it would need to re-program government computers that generate automatic payments as they fall due — a massive and difficult undertaking. Treasury makes about 3 million payments each day.”

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Double trouble for the euro zone

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When Europe opens down big due to the US deficit issues, it will send a chill though the investment community and euro zone leaders.

This is the last thing they need while struggling with their domestic financial issues.
With export markets threatened, and impossible domestic debt loads given the current levels of growth,
markets could force (via deteriorating financial conditions) an ECB takeover of all national govt. funding.

Kind of like breaking your leg and getting hit by a car while trying to limp home.

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SCENARIOS-Options for raising the U.S. debt limit

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And this and $20 will get you a cup of coffee.
I still see no sign of agreement.

Nor have I read anyone discussing the downward acceleration in GDP triggered when the spending limits are reached.
As previously discussed, GDP will accelerate as it falls, as the automatic stabilizers will be disabled.

So spending is further cut, sales go down more, more jobs are lost, and tax revenues fall more,
When the $150 billion/moth in govt spending stops in 2 weeks, sales fall, jobs are lost, and tax revenues fall, so spending is further cut, sales go down more, more jobs are lost, and tax revenues fall more, etc. etc. etc. until no one is left working.

(And it’s really bad for stocks, by the way, when no one buys anything.)

So seems they are underestimating the odds of no bill reaching the President’s desk.

And they are radically underestimating the speed and extent of the subsequent damage.

The problem is that most, probably including the President, believe the US takes dollars out of the economy when it borrows.
And therefore when it stops borrowing to spend the economy will have those dollars to replace the lost federal spending.
And so after the initial fall, it all come back that much stronger.

Except they are dead wrong.
And therefore we are all dead ducks.

Ever hear anyone ever say ‘I wish they’d pay off those Tsy bonds so I could get my money back and go buy something.’?
Of course not.
Tsy borrowing gives dollars people have already decided to save a place to go.
Dollars that came from deficit spending- dollars spent but not taxed.
If they were spent and taxed, they’d be gone, not saved.

Tsy bonds provide a resting place for voluntary savings.
They are bought voluntarily.
They don’t ‘take’ anything away from anyone.

For example, imaging two people, each with $1 million.

One pays a $1 million tax

The other doesn’t get taxed and decides to buy $1 million in tsy bonds.

Pretty obvious who’s better off, and who’s still solvent and consuming.

Someone tell the Democrats and the Republicans, thanks.

They are about to cut $150 billion/month in spending because they think it crowds out the private sector.
They really think the dollars the govt. pays out cause business to lay people off.
They don’t know that it’s that deficit spending that we get first as income that adds to our savings of govt. bonds.

And, of course, they also think they have no choice, as they all believe the US could become the next Greece, and face a similar financial crisis.

It’s completely inapplicable- Greece is like a US state, not the federal government- but they don’t know that.
No mainstream economist has pointed this out.
No one in the media has pointed this out.
So who can blame them?

I’ve never seen this kind of systemic risk looming in my 40 years in the financial markets.

So hope for the best,
and prepare for the very worst.

SCENARIOS-Options for raising the U.S. debt limit
(Reuters) – Democrats and Republicans in Congress, unable to compromise on how to cut budget deficits and raise U.S. borrowing authority, are now working on their own, competing bills.

 
With nine days’ left until the United States runs out of money to pay all its bills after Aug. 2, the two parties were rushing to get their respective bills moving through Congress this week. [ID:nN1E76M0B0]

 
Here are some scenarios for raising the debt limit by the early August deadline to avoid a potentially crippling government default:

 
* AN ALL SPENDING CUTS, NO REVENUES PLAN
This is the path being pursued by Senate Majority Leader Harry Reid, a Democrat.

 
Since tax increases that Democrats had been seeking were the major sticking point in negotiations with Republicans, Reid is simply removing the problem from the formula altogether.

 
Instead, he’s writing a bill that would achieve about $2.7 trillion in spending cuts over a decade while raising the $14.3 trillion U.S. debt limit by an identical amount.

 
If this streamlined plan were to pass Congress, there would be no need to revisit the divisive debt limit fight until 2013, after the presidential and congressional elections. Democrats would be glad to see no benefit cuts to popular Medicare, Medicaid and Social Security programs.

 
Financial markets would be happy that government borrowing authority is ensured through 2012.

 
* THE DISADVANTAGES
Some of the savings could be squishy, such as counting money not spent in the future on wars as the United States withdraws from Iraq andAfghanistan.

 
Also, overall deficit reduction is short of the $3 trillion to $4 trillion many had hoped for, including financial markets.

 
And there likely would not be anything in the plan to force future reforms of the cumbersome U.S. tax code and major benefit programs for the poor and elderly that will increasingly weigh on the federal budget.

 
The result could be that conservatives won’t go along.

 
And it’s unclear how U.S. credit ratings agencies would view the legislation.

 
* A SHORT-TERM DEBT LIMIT INCREASE
House of Representatives Speaker John Boehner, the top U.S. Republican, is going ahead with a two-stage program to achieve some spending cuts and a stopgap debt limit increase with plans to do another installment of both next year. He’d start with about a $1 trillion debt limit hike by Aug. 2, with a similar or greater amount of spending cuts.

 
Then, over the next six or seven months, Congress and Obama would fight over large additional savings — maybe from expensive benefit programs and by reforming the tax code — in order to get a second installment of the debt limit increase.

 
Boehner also might attached language requiring passage in Congress of a balanced budget amendment to the U.S. Constitution.

 
Tea Party conservatives who are important to Boehner’s political future have been pushing for such an ambitious plan and especially like the fact that it includes no tax hikes.

 
THE DISADVANTAGES
It is complicated, and sets up another difficult fight over the debt limit next year that could rattle financial markets. It could cause credit ratings agencies to downgrade the U.S. prized Triple-A rating.

 
* BLEND THE TWO IDEAS?
If the Senate were to pass the Reid plan and the House were to pass the Boehner plan, could the two be married?

 
Possibly. There could be a debt limit increase that carries through 2012 with no tax hikes, coupled with mechanisms to try to achieve more savings than Reid’s $2.7 trillion.

 
But leaders would have to work hard to find a “sweet spot” with just enough adjustments to get the necessary majorities for passage in Congress. And they’d be under an almost impossibly tight deadline.

 
MCCONNELL “FALLBACK” PLAN
A backup “fail-safe” plan first proposed by Mitch McConnell, the top Senate Republican, could be dusted off if it appeared the two sides could not reach a compromise on their competing bills.

 
Through a complex back-and-forth between the White House and Congress, it would allow Obama to raise the debt limit by $2.4 trillion in three installments through November 2012, when Obama and most lawmakers are up for re-election.

 
Under the McConnell plan, Republicans would not have to vote to raise the debt limit.

 
Obama has said that “at a minimum” the debt limit has to be raised and that he will take responsibility for that if the McConnell plan passes Congress.

 
House Republicans hate the plan, saying it would be a missed opportunity to get the big spending cuts they demand.

 
TALKS RESUME
It’s getting late to launch yet another round of negotiations, but at some point, leaders from both parties are going to have to work out either a brand new deal or one that accepts elements of their respective bills.

 
OBAMA INVOKES THE CONSTITUTION
This seems to be the most unlikely scenario.

 
Some have argued that Obama could ignore Congress if it fails to raise the debt limit and order continued borrowing by relying on the 14th Amendment of the U.S. Constitution.

 
The fourth section of the 14th Amendment states that the United States’ public debt “shall not be questioned.”

 
Obama has said White House lawyers had explored the option and they are “not persuaded” that it is a winning argument. But he did not rule it out.

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