Tags: US | debt | default | shutdown

The World Is Not Moving in the Right Direction

Tuesday, 08 Oct 2013 01:21 PM

By Hans Parisis

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After Dallas Federal Reserve President Richard Fisher said in a forum Monday at Southern Methodist University (SMU), "I deeply hope and I don't think we'll default, but it will come down to the wire," I've thought that for all categories of investors it could be good to refresh our memory for a moment what's written down in the Uniform Offering Circular (UOC).

The UOC sets out the terms and conditions for the sale and issue of marketable U.S. Treasury bills, notes, and bonds. It's important to take notice that U.S. Treasurys don't have a "grace period," which in plain English means if the U.S. Treasury fails to make any payment on any Treasury security an International Swaps and Derivatives Association (ISDA) credit event, or default, will be triggered after three days. Yes, you read that correctly. Exactly three days, that's it, period.

Believe me, this is extremely serious with far-reaching consequences for the United States as well as for the whole world. Of course, we aren't there yet (hopefully never!), but if that would happen, you shouldn't be surprised of the disproportional negative global impact such an event could ignite.

I hope when Treasury Secretary Lew testifies on the debt ceiling before the Senate Finance Committee on Oct. 10 we learn something more.

When we look back in history, it is reasonable to suppose it is possible that an accord on the government shutdown and a positive vote on raising the debt limit ahead of Oct. 17 could be agreed on and that would avoid any risk of a debt default later in the month.

But, that said, it is also extremely difficult not to look at the events of these last days, as well as those at the end of 2012 and those of the summer of 2011 and really. There are obvious reasons for getting worried about the actual state of dysfunctionality of the U.S. government.

In this context, it is important to take notice that on Monday and on Tuesday, China and Japan publically voiced their concerns about the threat that the fiscal standoff could pose to the value of U.S. bonds. Both Tokyo and Beijing have been in direct contact with Washington and have urged for coming to a deal on the debt ceiling that would eliminate "any" possible form of default that could let to devastating markets turmoil in many important places all over the globe. Chinese Vice Finance Minister Zhu Guangyao said it was the United States' responsibility to ensure safety of Chinese investments in the United States.

If that wasn't enough, we also must take notice that the Fed hasn't been able to send out a clearly defined message about its intended tapering. Let's hope they get their communication skills right once tapering gets finally underway.

And speaking of tapering, it's interesting to take notice at that same forum at SMU Fisher also said because the Federal Open Market Committee (FOMC) didn't have (enough) proof the economy was improving at its September meeting, the Fed decided not to start tapering.

Here we must say the Fed was right, as its standpoint was confirmed by the International Monetary Fund (IMF)'s World Economic Outlook.

I'm really wondering how much interest the Fed will give to a situation 1) "if" the labor participation rate would continue to go down, and 2) how would they see the impact of rising interest rates on what's called the "housing recovery."

Now, with the government shutdown still ongoing, which has now clearly interrupted the collection of reliable government statistics, it must be taken into account we'll probably see no Fed tapering announcement at the FOMC on Oct. 29 and 30 and even at their Dec. 17 and 18 meeting.

So, Fed tapering should be taken away for the moment and put back on the agenda at some time in 2014.

In the meantime, the political dysfunction in Washington has a real negative price tag, but that many politicians keep missing. I don't think it's an overstatement to say the cost to U.S. growth could easily be brought down to about 1.2 percent for the full year. I'm sorry, but such a kind of "recovery" would damage that much-needed confidence at a moment the U.S. recovery was still improving, albeit way too slowly. Let's hope they'll come to an agreement before it's too late.

Also, the Asia Pacific Economic Cooperation (APEC), which is a forum for 21 Pacific Rim countries that includes the United States, China, Russia and Japan alongside 16 other countries, just concluded its latest gathering and in its final statement read: "Global growth is too weak, risks remain tilted to the downside, global trade is weakening and the economic outlook suggests growth is likely to be slower and less balanced than desired."

To me, this statement speaks for itself, but, maybe I could add what I have already said here before: "Where Is the 'Real Good' Global Growth Finally Going to Come From?"

The IMF's latest World Economic Growth forecast cuts global growth in 2013 to 2.9 percent, which is the lowest number in four years, compared with a forecast of 3.1 percent in July. For 2014, they expect 3.6 percent, from. 3.8 percent in July.

The IMF cut U.S. growth forecast to 1.6 percent, from 1.7 percent in July, and for 2014, to 2.6 percent, from 2.7 percent.

Of course, these numbers do not take into account if a failure to lift the debt ceiling would occur.

The eurozone is expected to contract -0.4 percent in 2013 and to grow by 1 percent in 2014. Japan's growth remains unchanged at 2 percent in 2013 and 1.2 percent in 2014. China's growth forecast was lowered to 7.6 percent, from 7.8 percent in July, and growth in 2014 was cut to 7.3 percent, from 7.7 percent.

Yes, a lot of food for thought! No, the world is not moving in the right direction.

I don't think this is a good time to take on risks. We'll have to remain patient and wait and see how the U.S. debt ceiling fight plays out.

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