Liam Halligan: America appears to be sleepwalking towards disaster – does no one care?

Here is an excerpt from Liam Halligan’s splendid piece in today’s Telegraph:

There is now, according to S&P, “at least a one in three chance” that American debt will be downgraded from its top-notch status over the next two years – which would be a first in modern times.

Yet despite all this bad news, this veritable litany of woe, the Dow Jones Industrial Average ended last week at a three-year high. US equities are now at levels not seen since mid-2008 – before the credit crunch really took hold. On top of that, despite S&P’s announcement, the price of Treasuries kept rising, as their yield – the cost the US government must pay to borrow – fell to its lowest level in a month. Has the world gone mad?

Read more at the Telegraph.

7 Comments

  • I agree with Halligan: the world has gone mad. Stop it now. I want to get off.

  • chef says:

    I’m certainly no “investor”, but if the U.S government were going to default wouldn’t it be safer to invest in stocks? I’d rather buy McDonalds stock/shares over U.S treasuries, at least I know the product is ethical!

    Also the FED have been hoovering up Treauries for ages, so that might explain the price increase.

    Imo the U.S has a clear choice, they can continue to debauch the currency and wreck the entire country, or they can allow default to happen, enter a recession and finally come out stronger in about 4-5 years.

    • Tim Lucas says:

      Chef –

      I agree with you. I’d rather have the share of a good stable company than the paper of the government currently. On the S&P negative watch announcement, US treasuries rallied on the implicit assumption that equities are priced off the treasury – i.e. that the treasury is the “risk free” asset (so when investors feel nervous, they buy more of these), and that equities require some additional risk premium on top of this. This is one of the assumptions of modern portfolio theory and it seems like hogwash to me. It makes much more sense to assume that there is no risk free asset and that all assets must be assessed for risk separately.

  • Current says:

    Tim,

    Assets should be assessed separately for risk. I think the originator of the whole “risk premium” idea (Wicksell?) never classified government debt as risk free or even lowest risk. However, the bond market may have the last laugh because the US government can always tax away the profits of stocks to pay for bond coupons. (Of course those profits won’t go very far towards that end).

    The problem the US monetary authorities have now in recovery is that two “multipliers” are acting against it. Firstly, the demand for money will fall (I think it already has slightly). Secondly, banks will keep less excess reserves than they have recently. These things mean that to keep targeting the current inflation rate the Fed will have to sell treasuries. So, the value of treasuries will come under closer scrutiny.

  • joebhed says:

    Any monetarily sovereign government that borrows back monies that private bankers create – NOT the government – and issues its securities denominated in its own currency can never default except on purpose.

    http://bilbo.economicoutlook.net/blog/?p=11302

    S&P is totally wrong as usual.
    The ridiculously-inflated stock market bubble notwithstanding.

    • Current says:

      Yes, believe it or not practically every economist believes that government defaults are done “on purpose”.

      The issue is that if taxes can’t provide sufficient resources to pay debt interest then the government must create money or stimulate money creation. What you propose is that the government prod central banks to shift their policies so that commercial banks create much more money. There is then hyperinflation and government debt become worthless (along with lots of private debt). In some cases government’s can do that and in some cases they have to print the money themselves. But how is it better than default?

      Default may actually be better because it doesn’t disturb private contracts. There is a paper about this that studied South America and found that in situations of unsustainable debt default is better than very high taxes or high inflation.

  • AC says:

    The US dollar is the faultline, not the Treasury market. Of course they will never default on the debt because they can and will always print whatever nominal amount is needed to ‘repay’ the debt.

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