Monday, October 7, 2013

The Debt Ceiling: Nothing to do with Default...the Next recession?

“Default” isn’t really the issue, even though that is the term that the Administration and media use to describe October 17, the estimated date when the debt-ceiling is reached. 

The executive Branch (Treasury) piles fuel on the fire by claiming (from CNBC) that “…1) their payment system isn't set up to choose which bills to pay and 2) they have no legal authority to allocate money to pay bond investors and not, say, Social Security beneficiaries. That's Congress's job.” Quote from CNBC at…

While that may be partially true, it is also true that when the Government hits the debt-ceiling, Treasury does retain the authority to pay its obligations on previously issued debt; but it loses the ability to borrow more and increase the debt. I suspect that “default” to existing bond investors is illegal given that those obligations have already been incurred in “contracts” (treasury bonds/notes) with mostly foreign Governments.  These treasury debts would not be subordinate to other debts not yet incurred such as existing contracts.  We’ve seen Treasury use this philosophy throughout the recent banking crisis as Bond holders were spared from losses during the bank bailouts. I’m not alone in this belief. ZeroHedge says Treasury probably does have the ability to prioritize payments.  See ZeroHedge  at…

I’ve seen other discussion about how the Executive Branch could simply ignore the Debt ceiling and continue to borrow.  The argument here is that Congress’ failure to increase the debt-ceiling creates a Constitutional conflict since the Congress has passed laws directing programs to be accomplished, but has withdrawn funding by not raising the debt-ceiling.  With this “conflict” (so the argument goes) the President could choose how to violate the Constitution, since both alternatives (do the work or continue to issue new debt) supposedly violate the Constitution.  That is not entirely correct: it takes two acts of congress to accomplish anything.  Congress must grant Authority through an Authorization Bill and later, funding through an Appropriations Bill.   If funding is not forthcoming, the Executive branch can’t do the authorized work.  (This happens all the time – projects are authorized, but not funded or partially funded.) A failure to raise the debt ceiling is the same as failing to appropriate sufficient funds, except that it covers the entire budget, so there is only one legitimate alternative.

If Government can’t borrow more, it must instantly balance the budget. That has a certain appeal to some budget extremists, but the impacts to the economy would be huge if the government were to balance its budget instantly.  All sorts of contracts from planes to aircraft carriers would be suspended; most Government employees really would go home; Government research would stop; mass hysteria; dogs and cats living together…you get the idea. 

Estimates are that GDP would drop (I think I saw an estimate of minus 4%) and create a sharp recession probably worse than the Great-Recession. 

“The bank's base case now calls for "either a two-week shutdown or for multiple shutdowns." Additional, BofA has now cut its Q3 GDP forecast from 2.0% to 1.7% and from 2.5% to 2.0% for 4Q. It gets worse: "Much worse outcomes are possible. In our view, agreement is almost impossible as long as the Affordable Care Act is on the table." Finally, and what ties it all together, is that as a result of the lack of "government data", BAC now expects the Fed to delay tapering to their January meeting, or later.” Story at ZeroHedge at…

“The overwhelming majority of mainstream economists predicts that the world's biggest economy should have at least another two years before it runs into six months of negative growth (the official definition of recession). After 2015, however, the date for the next recession could be any time between the end of 2015 to 2018, according to economists' forecasts…"Ben Bernanke may be a remarkable man, but we are asking a bit much to assume he has abolished the business cycle and created the nirvana of never-ending growth," Robertson added….Historical data show a recession in the U.S. on average every 6-7 years since 1947, and double-dips within eight years of big recessions like the Great Depression.”  Story at CNBC at…

Monday, the S&P finished down 0.9% to 1676 (rounded) at the close.
VIX rose 16% to 19.41 as the level of fear continues to rise.

The 10-day moving average of stocks advancing on the NYSE fell to 47% Monday from 49% Friday.  (A number below 50% for the 10-day average is generally bad news for the market.) 

New-highs outpaced new-lows Monday, leaving the spread (new-hi minus new-low) at +10 (it was +114 Friday).  The 10-day moving average of change in the spread is minus 3. That just means that over the last 10-days, the spread has been getting worse.

Market Internals are Negative on the market for this short term indicator. 

Monday, the overall long-term NTSM analysis remains HOLD at the close.   

I remain about 20% invested in stocks as of 5 March (S&P 500 -1540).  The NTSM system sold at 1575 on 16 April.  (This is just another reminder that I should follow the NTSM analysis and not act emotionally – I am under-performing my own system by about 2%!)  I have no problems leaving 20% or 30% invested.  If the market is cut in half (worst case) I’d only lose 10%-15% of my investments.  It also hedges the bet if I am wrong since I will have some invested if the market goes up.  No system is perfect.