The Road to Default: Whaa???

Okay so here is what has been happening:
The yield curve has been going through a mad flattening- indicating that investors are "flying to safety" and that a recession may be looming around the corner. Why has it been flattening? Well, a string of bad news. For one, GDP numbers came out today and only indicated a 1.3% expansion. Considering the revisions in these numbers have been downward of late- this is not good news.  GDP has been expanding but at a slowing rate signaling a possible peak around the corner.

Furthermore, Congress still has yet to come to an agreement with Tea Party-ers being the party poopers by acting completely unwilling to budge with Obama and now John Boehner.  The situation does not look pretty. In fact, its unbearable to witness.

Additionally, consumer sentiment readings came out today at 63.7 which is consistent with recessionary levels.

The Contradiction:

SO we have been seeing people purchase treasuries instead of dumping them, like i had previously anticipated. Was i wrong? Clearly i was. What did i not consider? Treasuries are the most liquid and safe security on earth and quite frankly there is no close substitute.  Gold is not a substitute even though there has been quite the flight to it. Why? Its not very liquid and therefore don't depend on it as much for collateral.

Whatever the case may be we are seeing something extraordinary and totally expected:
TOTAL MASS CONFUSION

Please people! Keep Dancin'

Steven J.

The Road To Default: Still No Agreement

Another day and yet another failed agreement. The u.s. Is in trouble folks. Even if a debt deal is reached there is still widespread consensus that the u.s. will lose its AAA credit rating. More to come later.

Keep dancin'

Steven J.

A Quick Look At Unemployment

Labor market tightness is defined as the vacancies or job openings rate divided by the unemployment rate.  The theory goes that as job openings increase relative to the unemployment rate a tightness is created in that workers get the upper hand in wage bargaining power. Of course the opposite is also true- that is when job opening's are low relative to the pool of unemployed- then we face a situation where employers hold the bargaining power.

A current look at labor market tightness at below 30% reveals that the labor market is healing at a staggeringly disappointing pace. Given the recent jump in the unemployment rate and the slight increase we've had in labor market tightness, one can reasonably argue that the unemployment rate increased do to structural factors.

This is because the relationship between vacancies and the unemployment rate - called the Beveridge Curve is a representation of Labor Supply and frictional mismatch among other things, and Labor Market Tightness is sometimes referred to as determining the slope of a Labor Demand curve.  So as Labor demand has slightly picked up since the dark days of the recession and the unemployment rate has still increased- labor supply or mismatch must be playing a dominant role.  I have not looked into the specifics of the Employment Situation so i don't know what exactly is going on, but i would say that it probably has to do with previously discouraged workers re-entering the labor force.  I really would have to peruse through JOLTS and The Employment Situation to fully diagnose the severity and causes into the recent spike in the unemployment rate.  Maybe when i'm not feeling so darn lazy.

keep dancin'

Steven J.

The Road to Default: The Other Side of the Story

Okay so I was gliding through the articles of CNBC.com and stumbled upon one titled, "A Downgrade of U.S. Debt Won't Matter as Much as You Think." The argument laid down in this piece is that insurance companies and pension funds are required to hold high quality assets and that U.S. Government debt -no matter what rating is slapped on it- will still be the highest quality asset you can purchase.  My view is that although these institutions may not dump their treasuries- somebody else will.  To the extent that "somebody else" does will also dictate the losses these holders and the financial community sustain.
 On another note- John Carney writes in the same article:

It’s very likely that a downgrade of the credit rating of the U.S. would trigger a sell-off, but it’s far from clear that investors would sell U.S. government debt. More likely the investors would sell risk assets—equities, high yield corporate bonds, mortgage securities—and actually buy U.S. government debt.

It just doesn't make much sense to say that a downgrade by a ratings agency will cause people to buy more not less of that security.  Every single downgrade in the Eurozone has caused a sell-off, why should it be different here?

Keep Dancin'

Steven J.

The Road to Default: Puppy Power!

Although Congress can technically dilly dally until August 2nd to come up with an agreement and raise the debt ceiling- markets have anticipated the inevitable. They haven't sat back and decided to wait till August 2nd to panic- they are already in "oh shit" mode.  On this note a recent CNBC interview with David Murrin suggests that I am not alone:

A U.S. default isn't a matter of "if" but "when," David Murrin, chief investment officer at Emergent Asset Management, told CNBC. "It's inevitable that the U.S. will default—it's essentially an empire which is overextended and in decline—and that its financial system will go with it," he said.

Uncertainty about what Congress is going to do has forced investors to assume that Congress will screw it up.  Steven Hess of Moody's explains this as "event risk" and today suggested that the United States eliminate its statutory limit on government debt to reduce uncertainty among bond holders.  

"The current wide divisions between the House of Representatives and the Obama administration over the debt limit creates a high level of uncertainty and causes us to raise our assessment of event risk," Hess said.

This additional "event risk" is just one additional factor that encourages ratings agencies to downgrade the United States AAA credit rating. 

Unsurprisingly enough, we have already seen the Dow Jones fall 1.1% today. Surprisingly, Treasury yields have remained unscathed. Furthermore, there has been an increasing capital "flight to safety" as Gold hit a new high today. Investors are just chillin' and waiting for the news that will trigger the dumping of Treasuries. I have a feeling that this is the present situation because investors aren't buying Treasuries, but they're also not selling them, instead we see the flight to safer assets from stocks directly to Gold and Silver. I will be following the news as it unfolds with both ears perked ready to hear the verdict. This is the casey anthony trial for the financial markets.

Who is going to save the world? Will it be a bunch of cute puppies fighting crime and licking the face of someone in a state of post traumatic stress? Unfortunately, i don't think any amount of cute puppies will be able to cause congress to agree on a sustainable and credible debt deal in the near future.  That is why I ask who is going to save to world? If not cute puppies- then who? 

Timmy G of the U.S. treasury? Benny B of the Fed? Or will our nation just rise up like Chris Angel and produce a resolution out of thin air?

Keep shufflin'

Steven J.

The Road to Default: Deep DooDoo

Okay so what is the situation at hand? Well the inevitable default of the United States of course.  The U.S. will default regardless of whether Congress raises the debt ceiling. You may be thinking the following: But how can he say such a thing? Is there anything we can do to stop it? There is no way that can be true!

Let me convince you that we're in deep shit.

First: Look at Italy. Until this past week they were considered a safe haven for bondholders. Then their eurobonds jumped up to 6% because investors got spooked. Nothing happened that would suggest that they are in fiscal demise. There is no real political instability or real danger of default and Italy's banks are relatively well capitalized with mostly retail deposits.
The U.S. on the other hand has had petitions being signed by influential economists and businessmen urging congress to raise the debt ceiling to come to an agreement.  We also have had default and debt recently come to the center stage and center of attention. In financial markets, anything that even gets a little press ends up being way worse than initially anticipated. For examples of this just look at the subprime mortgage market and how early warning signs were easily dismissed.

In Charles Poor Kindleberger's famous book on the history of financial crisis, one of the most tell tale signs of a major breakdown looming is when a central banker or someone important gives an early warning. The example we can draw from is in 1996 when then chairman Alan Greenspan warned of "irrational exuberance" to describe the tech bubble.  In terms of prescience we have seen numerous warnings from Benny Bernanke about our debt buildup.

No matter what happens the U.S. will default. Cautious investors should get the picture if they haven't already that now is the time to cash out and see what happens.  I could be wrong- but the turbulence that will ensue regardless as Congress fights over what to do will not be worth the hassle.  My game plan would be to buy back in when yields spike and they could spike by quite a lot. S&P was even recently taking about downgrading U.S. treasuries to AA status regardless of a debt ceiling negotiation.  Yields will spike. I promise you and now you have to promise me to keep dancin'

Steven J.
  

Sir Sun Drop

Okay so one of my best friends Sir Kris "Wespro" Wesslen has started a new blog and i think it's so hilariously decked out with pompous amounts of hilarity that even a blind and brainless mouse would chuckle out of amusement. Please check it out here. It is hysterical, innovative, pointless and a break from the daily rigermaroll of life.  Also please check out this hilarious video he made about Sir Sun Drop.

Sir Sun Drop from Kristian Wesslen on Vimeo.

The Road to Default: Debt Ratio Comparison's With Previous Episodes

In 2009, Carmen M. Reinhart and Kenneth S. Rogoff wrote a book titled ,"This Time Is Different" about debt and financial crisis. One of their charts will provide a benchmark for us in our analysis.  This chart can be found on page 121 of the book and shows the ratios of public debt to revenue immediately preceding an external default.  For Africa the external debt/ revenue ratio was 1, Asia it was 1.5, in Europe it's 1.6ish and for Latin America its closer to 3. As the following chart explains our current ratio in the United States is around 1.7ish which is higher than in Africa, Asia and Europe at the time of an external default.

Additionally the chart in "This Time Is Different" also compares the ratios of total debt to revenue at the time of the default.  For Africa is was 2.6ish, in Asian countries the ratio lies around 4, in Europe it hovers around 3.75 and for Latin America around 4.6ish. As the following chart shows, we are considerably past this doomed territory with a public debt-to- revenue ratio of around 5.61 and climbing. The following graph I did in R because it just seemed easier. 

 So the lesson's learned today are that by history's benchmarks the U.S. is way past the point of no return and all we can do is hold on for the ride of a lifetime or prepare for the Federal Government to cut spending by a large enough amount that real GDP growth will most likely slow to a stall. It's a lose-lose situation. Prepare for pain, but keep dancin',

Steven J.

The Road to Default: Who's getting the most screwed?

Let's take a look at who gets the most screwed (who loses the most money) when bond prices collapse and the United States defaults.

Well until recently only about 55% of treasury's were held domestically. The rest was externally held by places like Japan and China.  Now something like 67% is held domestically, which means when shit hits the fan, the majority of the burden will be on the U.S., however that isn't even the 1/3rd's of it.  Considering that 33% is held externally, we could be in some trouble especially if China keeps looking to the Euro to diversify its investments.  We could see even further downward pressure on treasuries leading to an even higher interest rate burden.  I know I will keep shuffling through the default, but will John Boehner? The dude who has refused to make a deal with the Democrats despite pleading from the Economist Magazine, President Obama, Chairman Benny B and Financial Markets everywhere. Good luck America and keep dancin,

Steven J.

The Road to Default: We Crumble Like A Cookie

What should we be expecting when the United States defaults and how will this unsavory process unfold? Well for one thing anticipate the downfall with a downgrade in the credit rating.  According to recent Bloomberg article in the event of a U.S. default, Standard & Poor's would lower its sovereign top-level AAA ranking to a D, and Moody's would lower it to the Aa range.   The lower credit rating's would be absolutely disastrous for the bond markets because corporate bonds usually move in sync with treasuries and a default would lead to a sudden reversal of this standard procedure.  In the graph we compare interest rates on Moody's Aaa Seasoned Corporate Bond's with both the 3 year and 10 year treasuries.  Notice that Moody's rates are currently around 5% and we're now paying below 1% on our three year treasuries.  Now logically consider if Moody's downgrades our debt to Aa status- in the best case scenario we see a rise by at least 4-5% in interest rates.  Why will the rise be so sudden? Many insurance companies and pension funds, by internal mandate, hold only the absolute safest of securities. This means AAA only ratings are allowed.  Once treasuries get slapped with a lower rating- these funds will be forced to sell causing a massive decline in bond prices and an unprecedented spike in interest rates.  This spike in interest rates would make the most liquid market on the planet freeze up causing both a financial crises and a political one as well. For one, medicare and social security payments would have to stop. Second, treasuries are held on banks balance sheets as collateral, if they lose an unprecedented amount of value, we could see a banking crises as even cautious institutions may find themselves in an unhealthy cash position. Even U.S. credit defaults (CDX North American Investment Grade Index) swaps have climbed to their highest level since October! This is certainly not the beginning of this story, but it ain't over till the fat lady sings.


keep dancin'


Steven J.

The Road to Default: Let's Look at the Damage with a Rant.

The following graph shows Real GDP as a percentage of the Gross Federal Debt.  FRED is the resource I frequently use for United States financial data and it serves us well here.  


What is Gross Federal Debt? Well, its total government debt outstanding- including all the various agencies. 
Why do we compare real GDP with it? We want to hypothetically see that even if we have a 100% tax rate  for one year and kill every business we still couldn't eliminate all of our Government debt! 
Notice that we are at above 100%! Default is inevitable! Raising taxes (aka revenue) is frivolous at this point, the only way to bring this unsustainable rise in debt down it to deleverage by way of default.  This is the only way because our politicians are resolved to not do anything and to see what happens. Their lives are more important than ours and that is why they may refuse to engage in political blasphemy (cutting medicare, down sizing social security payments, ending unemployment benefits). 
The Republicans & FOX NEWS will blame the default on President Obama and John Stewart, no matter how ridiculous and untrue that may be. 

The Daily Show - Oh, for Fox Sake - Stewart Eviscerates Stewart
Get More: Daily Show Full Episodes,Political Humor & Satire Blog,The Daily Show on Facebook

 The Democrats will blame it on the Republicans refusal to come to a deal sooner.  In the end both will be severely discredited. I will blame it on our political system. It dooms us. How can anyone make a politically unpopular decision when they are worried about getting re-elected? They can't and they won't most likely.  Our country is in trouble and it's not because Casey Anthony was found not guilty, that we don't allow drilling in the gulf, or that we have millions of illegals pouring over the border.  It's not the small and meaningless stuff.  It's the structure of our broken system, the stubbornness of our elderly, and most importantly it's a failure to be truthful and do what's right.  

A few words from a recent speech by my main man, Benny B:

"The nation's long-term fiscal imbalances did not emerge overnight. To a significant extent, they are the result of an aging population and fast-rising health-care costs, both of which have been predicted for decades. The Congressional Budget Office projects that net federal outlays for health-care entitlements--which were 5 percent of GDP in 2010--could rise to more than 8 percent of GDP by 2030. Even though projected fiscal imbalances associated with the Social Security system are smaller than those for federal health programs, they are still significant. Although we have been warned about such developments for many years, the difference is that today those projections are becoming reality."

We have a severely flawed tax system that would cause no uprise if only it was consumption based, a financial system that gets drunk every year off new financial innovations and lack of regulation, and media that "tells" the truth- even when they lie. I'm not a religious man, but God help us! 


Keep Dancin'


Steven J.

The Rebirth

Hey guys, I know that I have been gone for awhile now.  I just came back from a month long euro adventure so have no fear, I have plenty of time to devote to blogging now.  From this day forward, X.U. Economics will be known as The Dancing Economist.  WHY?!? Well first of all, Xavier University although they slightly endorsed this work, has done nothing to contribute to it's success or survival.  Second of all, I have written nearly every post with the exception of one. Third, I like dancing and will be teaching dance at an Arthur Murray studio for a year before I pursue my PhD.  Fourth, it's catchy!
So sit back, relax and enjoy the show folks because this country has a lot going on right now. Of particular interest is the debt and the inevitable default of the United States.  In my very first blog post I was calling for a default of the U.S. in 2012 because of the inability of our nations leaders to accomplish anything. Looks like I may be more right than what I had wished for.  In the next few series of posts, I will be doing my absolute best to explain the risks the U.S. faces in the short and long term, the policy options available, and possible scenarios. Please hold on because we may experience some major turbulence!