Markets Ignoring Phony Debt Crisis

07/15/2011 11:04 am EST

Focus: MARKETS

Igor Greenwald

Chief Investment Strategist, MLP Profits

And in so doing, they’re making it harder for the politicians to reconcile their incompatible principles, writes MoneyShow.com senior editor Igor Greenwald.

Two weeks ago, I wrote that my children had slightly better negotiating skills than the adults in Washington, DC.

In light of everything that’s happened since, I can only say how very, very sorry I am, kids.

Predictably, opening positions staked out in the debt-ceiling talks have hardened into immovable points of principle:

  • Republicans have disowned any and all responsibility for raising federal tax collections as a share of the economy from their 60-year low. Many on the party’s right are intent to starve the government of funds in the fervent hope that it wastes away.
  • Democrats have taken off the table consideration of meaningful reforms of the bedrock social programs—Social Security, Medicare, and Medicaid—that are plainly unsustainable in even the medium term in their current form.

The latter two programs are in trouble, because last year’s health-care legislation did nothing to effectively contain out-of-control spending—as shown by the huge rallies in health insurers’ stocks. Health insurers, who manage a system that spends at least double what any other rich country spends on medicine to achieve similar outcomes, are no friends of cost containment.

In the absence of much progress on that front—insurance premiums are still rising by double digits in many places—Republicans get to argue that the benefits the programs provide are unaffordable, and should be curtailed.

And so the stalemate drags on, and will until just past the seeming point of no return, because ultimately no one much cares.

Certainly not the owners of Treasury notes and bonds—if they did, yields would be more than a smidge above multi-generational lows. Other investors also don’t seem overly perturbed: if they really believed all the imposing warnings that apocalypse awaits if no deal is reached by August 2, they’d be exiting stocks in a hurry.

In fact, the S&P 500 was at 1,320 on April 17, the day before Standard & Poor’s placed the AAA US debt rating on a negative outlook, indicating a one-in-three chance of a downgrade over the next two years.

And though the action cost the S&P 500 a quick 15 points, it was back at post-crash high two weeks later.

Now here we are, and S&P has just placed that AAA rating on negative credit watch, giving at least even odds of a downgrade within three months—barring “a credible medium-term fiscal consolidation plan in the foreseeable future.”

The chances of that would seem to have been reduced to slim and none, and slim is buying tickets at DC’s Union Station.

Yet the S&P 500 is at 1,315 in early trading. So three months of inaction capped by acrimonious and unproductive budget talks have left stock prices almost exactly where they were, while bond prices have actually rallied as a result of an economic slowdown.

This only strengthens the deadlock, of course, because Tea Partiers look at the stable financial markets and lofty bond prices and conclude that the August deadline is a phony one worth busting on principle.

Chances are still pretty decent that the old-fashioned Republicans and Democrats will fashion a compromise to stave off temporary default. But they’re not as good as they were two weeks back.

NEXT: 2 Things to Consider

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Beyond the jockeying over how the debt ceiling is actually raised and who gets to claim victory when it is (bet on everyone), two points worth keeping in mind for the longer haul:

  • The dysfunctional budget talks are a product not of political opportunism, or ill will, or the difficulty of the task at hand, but of incompatible values.

One side believes the social protections accumulated over the last 80 years deserve to survive in their current form, if on a reduced scale. The other side doesn’t.

One side believes that the ideal level of taxation today is less than yesterday, trending inexorably toward zero over time. The other doesn’t.

This is what happens when you cram two (and arguably more) distinct cultures and value systems into a single, continental colossus of a country. Ultimately, the schizophrenic colossus becomes ungovernable, a fact the S&P is belatedly waking up to.

  • Lifting people out of poverty with wealthy-country technology is simply a lot more profitable than elevating already-prosperous people to some higher plane of material well-being.

Check out this National Geographic map, which overlays population densities over national income levels. Note the three bright-blue patches of relative prosperity among the purples, reds, and yellows coloring the bulk of the inhabited world.

The happy islands of wealth are, of course, the US, Europe, and Japan, and it’s no accident that each of these is struggling economically, as the investment that drives growth goes elsewhere. Poor people work for cheap, hence the opportunity.

So let’s stop talking about fiscal deficits like they’re a symptom of some national moral rot. They’re a symptom in the main of the firing here and the hiring over there, as global companies take advantage of wage differentials.

How society adjusts to this trend is up for debate. But there’s no arguing the fact that debts public and private have been run up for years to compensate for a lack of investment and growth that went elsewhere.

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