Harry Potter and the Deathly Debt Deal

08/01/2011 10:30 am EST

Focus: MARKETS

Igor Greenwald

Chief Investment Strategist, MLP Profits

The fake crisis in Washington resolved in the worst possible way, without action on debt or the economy, writes Moneyshow.com senior editor Igor Greenwald.

Americans love happy endings almost as much as we like borrowing money, so the only surprise is that anyone should be at all surprised by the debt ceiling deal struck in Washington at the last possible moment.

The final bit of budgetary hocus-pocus got done while I watched the new “Harry Potter” movie, the one in which (spoiler alert!) the hero is meant to die in order to save the world from evil, but inexplicably gets to live happily ever after and even send his kids off to boarding school. (The Ministry of Magic is evidently exempt from discretionary spending triggers.)

As for us Muggles, we get the next-to-worst possible world, other than perhaps the narrowly avoided default.

Faced with a pressing crisis of joblessness and underinvestment and the long-term problem of the soaring national debt, inflated primarily by runaway health-care costs, the badly divided government compromised by agreeing not to address either issue.

It spent months dickering about deficits that could total $13 billion over the next decade, and in the end, could identify a mere $900 billion or so in savings over that span. Another $1.2 trillion might get lopped off in 2013 unless a bipartisan committee comes up with a better plan this fall, assuming the politicians in charge in two years’ time don’t decide to renegotiate everything.   

And meanwhile the only hope this deal holds out for the millions of long-term unemployed is that all the “job creators” out there—certifiably an endangered species—won’t immediately get hit with higher taxes. And also that, barring action by a new Congress, government spending will quickly shrink by $200 billion or more in 18 months, representing a non-trivial 1.5% of the GDP, just as the Bush tax cuts are due to expire.

So this is the “happy ending” that had stock index futures up more than 1% this morning, amidst relief that the US government won’t immediately default on its obligations. After another month of heavy outflows from stock mutual funds, it’s not surprising that short bets are being covered now that another Lehman-style credit collapse is off the menu, at least not until Europe runs out of obfuscations.

But the deal also means the very real US budget crisis now won’t be seriously addressed until 2013 at the earliest, and in the meantime, the economy is likely to remain on life support from the Federal Reserve.

Those bullishly inclined (and I’m less so than I was in May or June) can at best argue that the deal preserves the status quo underpinning ample corporate profits.

But the stock market’s callous disregard for the shabby state of the US economy may not last as long as investors hope.

And Washington’s inability to address either the long-term deficits or the near-term economic weakness is a big plus for gold and other precious metals, as well as for commodities in general. The sub-par economic outlook is what’s driving the rally in bonds, and warranting low US interest rates for years.

If the US economy underperforms over the long run―and this deal will make it hard for it to do anything else―holders of dollars will continue to seek out alternatives to the world’s former reserve currency. And the alternative of choice has been gold, followed by oil, grain, and other metals and foodstuffs.

Gold futures were down 0.6% from the record this morning on news of the deal and have been steadily inching up from Sunday’s lows. That’s almost certainly not the beginning of the end for the decade-long bull market in bullion.

At one point in the latest “Potter” a goblin refuses Harry’s offer of gold, demanding a magic sword instead. Washington is out of magic these days, but it does have one trick on permanent display. Its creditors may wish for gold, if not a pound of flesh. What they will get instead is an inexhaustible supply of dollars.

Related Articles on MARKETS