Friday, July 29, 2011

The Canadian Perspective on the US Debt Ceiling Crisis

Here are some gems from a publication by the Bank of Montreal's economic research team in a publication entitled Focus:
The market’s message to Washington from the five-day slide in the Dow can be neatly summed up in two words: You Idiots!

Part of the requirement for a country to be rewarded with a AAA credit rating is political stability and a clear willingness to repay debts—the fiscal fiasco calls the U.S. into question on both counts. Perhaps the most distressing aspect of the entire mess is the stance taken by some very senior leaders. The candidate currently in second place for the Republican nomination for President has openly stated that she would never support an increase in the debt limit. While it may be too much to ask for every politician to have an advanced degree in economics, it’s not asking too much that they have an ounce of common sense.
And this:
The stalled vote by the House of Representatives further delays a resolution of the debt ceiling crisis and raises the odds of a government shutdown next week. Tea Partiers’ refusal to support the Boehner Plan might well mean that they get the political onus for a shutdown and possible default. For sure, the Democrats will play it that way. The only thing that is certain about the current impasse is that it is unambiguously bad for the U.S. economy, which grew at a much slower pace than previously thought in the first half of the year.


The last thing the U.S. economy needs now is further disruption from Washington and dramatic tightening in fiscal policy.
And this:
Evidence is mounting that fiscal uncertainty is harming the U.S. economy. Consumer spending nearly stalled in the second quarter, and not simply because of the lesser availability of cars and higher cost of driving them. Consumer confidence tumbled in July, and a weekly measure of sentiment plunged after S&P upped its downgrade warning mid-month. Despite stellar profit growth at large multinational companies, firms unexpectedly cut durable goods orders in June. Although pending home sales rose surprisingly last month, a pullback in mortgage originations suggests sales weakened in July. The Fed’s Beige Book said more regions are slowing, with companies in the Chicago Fed District citing “heightened uncertainty about the economic outlook given recent weaker-than-expected demand as well as the ongoing fiscal issues in the U.S. and Europe”.

Investors and banks are taking extra precautions in the event of a fiscal “accident”. Money market funds are hoarding cash in the event of redemptions. Banks are conserving liquidity, restricting the supply of much-needed credit for businesses and homeowners. This is despite the fact that mutual funds, banks and insurance companies are under no obligation to unload their Treasury holdings in the event of a downgrade. A survey by the Association of Financial Professionals said that, in the event of a failure to raise the debt ceiling, half of treasury and finance executives would take precautionary action (read: cut hiring and outlays) to conserve cash.

Even if the debt ceiling is raised in coming weeks and a default averted, as is highly likely, the extreme partisanship shown by lawmakers risks pushing the fragile economy back into the mire.
Americans should contact their Congressional representatives and thank them for ensuring that they will enjoy the equivalent of the Great Depression's "double dip" with the 1937 recession within the depression.

Click to Enlarge
By 1936, all the main economic indicators had regained the levels of the late 1920s, except for unemployment, which remained high. In 1937, the American economy unexpectedly fell, lasting through most of 1938. Production declined sharply, as did profits and employment. Unemployment jumped from 14.3% in 1937 to 19.0% in 1938. A contributing factor to the Recession of 1937 was a tightening of monetary policy by the Federal Reserve.
Americans will have the Republican party to thank for this trip down "memory lane".

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