Tags: US | default | EU | uncertainty

Washington Will Kick the Can . . . Again

Tuesday, 15 Oct 2013 02:26 PM

By Hans Parisis

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In my opinion, the most probable outcome for the Washington stalemate on budget talks and raising the debt ceiling will be, once again, one of those temporarily solutions of "kicking the can," of which the United States, but also the euro area, seems to have made it one of their frequent and favorite "ready at hand" patching tools. This, of course, doesn't resolve any of the real underlying causes for the ongoing problems.

That said, I still don't expect there is a serious risk the United States would "legally" fully default on its debt this week and even at any time thereafter.

Let me explain in short. It's very important not to overlook the remarkable fact that U.S. Treasury notes and bills don't have in print (documented) anything that sets out the bondholders' rights, which means in clear English that we have an extremely exceptional situation where there are no clear safeguards because of the complete lack of cross-default clauses.

When cross-default clauses apply, which is normally the case for all important bond and loan issues, a failure to pay one or more "important" liabilities by the issuer causes immediately a catastrophic situation whereby all the issuers' other liabilities become immediately due.

We could say because of (or thanks to) the lack of cross-default clauses that are applicable on U.S. Treasury bonds and bills, a short-term default should not trigger immediately a far worse than a "Lehman-like" cataclysmic event that would put immediately in default the full $16.7 trillion of U.S. debt.

So, in case the United States would pay a little bit later than was originally planned what it owes on its Treasury bonds or bills, "strictly legally" spoken that would not constitute a default.

Let me add that this situation is what it is, but also at the same time that this strange situation is certainly not constructive for building further confidence after what we are experiencing this time around.

In my opinion, all long-term investors should keep in mind that serious damage is already done to: 1) the credibility of the United States, and 2) implicitly, for now at least, in the long run to the dollar. Please don't get me wrong, I'm not saying this situation is irreversible, but it's really becoming close to 12 for the United States to change radically course and get its fiscal house in order.

Already, China's Xinhua news agency made a remarkable comment on Sunday by saying: "[I]t is perhaps a good time for the befuddled world to start considering building a de-Americanized world. . . . The cyclical stagnation in Washington for a viable bipartisan solution over a federal budget and an approval for raising debt ceiling has again left many nations' tremendous dollar assets in jeopardy."

Keep in mind that China holds $1.28 trillion of U.S. debt, the most in the world outside the United States.

Now that in January Janet Yellen will most likely become the new chair of the Federal Reserve, long-term investors could ask themselves weather the Fed will really start tapering its bond-buying program as already was first signaled by Fed Chairman Ben Bernanke in May of this year or it will instead continue its quantitative easing policies, which could easily be seen by the world as a form of the Fed trying to monetize U.S. debt and a continuation of "benign neglect" concerning the value of the dollar. Let's hope it doesn't come to that.

Maybe a good way for currency reserve-accumulating countries like China to bring down their holdings of U.S. dollars is to fully liberalize their own currency regimes. Of course, again, that's another extremely difficult question.

Now when questioning if all that would mean the dollar is on its way to finally lose its reserve currency status is, in my opinion, not in the cards because of the very simple reason there is still not one single credible and doable alternative to the dollar on the horizon yet, notwithstanding the so-called "risk-free" rate is gone and maybe forever.

Talking about the eurozone for a moment it is noteworthy that in German Chancellor Angela Merkel's team didn't wait until the newly elected government is in place for pouring cold water over the latest proposals for a EU banking union.

It is understandable in Germany that fears remain its taxpayers would still be in line to foot the bill for failed banks in other EU states. Well last Friday, Finance Minister Wolfgang Schaeuble told reporters, "There will be no European backstop, but rather national backstops," which means that every EU member state is financially responsible for its own banks and not for those of other member states.

Let me remind you, at this moment, the United States gets practically all the attention, while the European "fiscal union" is still in the "making" because Brussels has now decided the euro area will be ruled by the Stability and Growth Criteria II, which clearly falls short of the initially planned fiscal union. It is clear serious barriers remain on the eurozone's path to long-term viability as a stable economic bloc where the euro reflects the real economic value of all member states and not only that of a few.

I don't think it's an overstatement to say that today uncertainty is king, but there is a lot of hope and wishful thinking going around.

I prefer to remain calm with both feet on the ground and wait and see.

This is not a time to take on long-term investment risks that are extremely difficult to calculate, let alone to foresee at a moment the G20 just stated that the global recovery remains uneven and fragile, unemployment remains as one of the greatest global challenges and where fiscal discipline should be followed by structural reforms that finally should contribute to sustainable growth.

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