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Government Shut-down and Looming Debt-ceiling Crisis

October 09, 2013

 

The US government shut-down and looming debt-ceiling crisis are not easy to play in the markets in terms of finding clearly favorable reward/risk, especially if the shut-down lasts into October 17th when debt-ceiling problems begin to become more substantial. We have the first government shut down in 17 years underway, the 17th such shutdown since 1976, with the median shutdown lasting four days and the longest lasting 21 days. MS economist Vince Reinhart suggests that each week is likely to represent a 15 bp drag on Q4 real GDP growth (because GDP is a ridiculous measure of something that pretends like spending is more important to measure than output and income generation). Markets are now beginning to rollover, but should the shut-down last to October 17 when the debt-ceiling must be increased, additional problems and market concerns could develop. The BLS key NFP report on Friday was delayed. Since 1976 in prior shut-downs the S&P fell between 2.5 and 4%. However realize that the debt-ceiling fight is often a much bigger concern for markets, with the S&P declining nearly -14% in 2011 when the debt-ceiling impasse was last a major issue. Obama actually is trying to talk markets down to pressure Congress. The Federal Budget was around $3.8 trillion in 2013, representing nearly 23% of the $16.5 trillion in total GDP. While the slowdown in spending that the shutdown creates pushes off growth into future quarters for as long as the shutdown lasts, when statistics stop coming out there is also a growth slowdown from decreased clarity in the economic outlook and the ramp-up required in time to get data back in gear, as economic forecasts become less meaningful and more opaque.

 

Another reason to remain slightly more cautious towards risk-on risk in markets during this final phase-up of the cyclical bull market has to do with macro fundamentals that remain far less robust than normal during a cyclical bull market. US consumer spending remains near 2%, the lowest ever in an economic expansion. The US birthrate has dropped to the lowest since the 20's and 30's. Unemployment is not really getting any better as the only reason the official number has improved is because more and more people are not looking for work out of pure frustration. Nor is productivity rising sharply or real-incomes improving much. Capital spending is not picking up sharply, something that normally precedes the significant productivity improvements that can propel real incomes sustainably. Total debt is still very high near 350% of GDP, government debt has soared to 100% of GDP officially and the unfunded liabilities of Medicare/caid and Social Security continue soaring to $60 trillion and climbing, while the underlying problem is not remotely being addressed.

 

Now even the CBO, whose projections have proven nearly universally overly-optimistic with regards to spending short-falls over the years, projects that by 2025 entitlements and interest on the national debt will eat up all of US government tax receipts. To avoid this fate which would lead to market riot by the US bond and dollar markets, government will either have to dramatically reduce entitlement spending, dramatically increase taxes, or attempt to default in some ways via inflation. A key for markets will be when real bond and/or dollar rioting begins and whether it happens soon enough to forestall a new round of high inflation or not. We don't know the answer to this $64 trillion question, and will have to watch market action closely to assess in the period ahead.

 

As Niall Ferguson recently pointed out in a WSJ op-ed, "only a fantasist can seriously believe 'this is not a crisis' .[as] the fiscal arithmetic of excessive federal borrowing is nasty even when relatively optimistic assumptions are made about growth and interest rates." Ferguson suggests that we are watching a slow-motion game of "Russian roulette" being played with the Federal government's credit worthiness. Investors are advised to understand this and regard carefully its full implications.

 

If intervention and central planning worked, productivity would have soared during attempts at fascism, communism, and socialism of the last hundred years, whereas in reality productivity universally fell, just as it is now doing across the globe. Capitalism requires disruption and invention and creative destruction, whereas money printing and bailouts creates zombies and prevents new innovations from developing or being implemented. Any time central planners have been given a mandate to try and be responsible for employment and/or production, both have declined in ways those central planners have neither understood nor intended. Money printing can appear to drive wealth near-term, but it doesn't increase production or innovation or capital investment or a proper response to real market indications, and therefore it doesn't sustainably do much more than borrow growth from the future and retard it on a long-term basis. Companies and ideas must be allowed to flourish and to fail to provide entrepreneurs with the correct messages so that knowledge can grow and production can grow. Creativity and innovation such as the discovery of how to produce electricity or how to increase factory production with an assembly line did not come from government in history, they came from individuals and were a surprise to central planners and government. It is those surprises of entrepreneurs that must be allowed to grow because that is where new innovations and products come from.

 

Whatever interferes with markets interferes with the messages and communication between producers and consumers, and by interfering with these key messages, government intervention simply impedes growth and potential for new innovation and ideas that work to flourish. Intervention with markets is like noise disguising the true signals that entrepreneurs need to be most efficient and to make the most substantial changes to improve productivity and the wealth and living standards of mankind as the "engine of disruption and innovation" that is capitalism is undermined.

 

The productivity and wealth gains of capitalism over the last 200+ years have been mind-boggling on a historical basis, and the keys to continuing such growth via capitalism are the application of the "rule of law" equally throughout society, the "defense of property rights, the reliability and restraint of regulation, the transparency of accounts, the stability of money, the discipline and futurity of family life, and a level of taxation commensurate with a modest and predictable role of government.[which] bear all our bounties of surprising wealth and progress." Meanwhile as long as authorities and peoples believe in intervention, they will produce more unintended negative consequences of their intervention that will only grow over time and retard growth that much more. US Spending is out of control, and both political parties are to blame since they have co-created a structure of Crony-statism, auctionocracy, and intervention that must be structurally changed for sustained prosperity and freedom for mankind on this earth to return.

 

Investors should be reminded in this environment that there are uncorrelated alernative strategies available that can perform independently of traditional buy/hold strategies in stocks and bonds, such as our Novus Precious Commodities program (limited to QEP investors).

 

Past performance is not necessarily indicative of future results. The risk of loss exists.

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