The State of Union address is over and the spin has begun. We heard a great deal but are concerned that there was little mention of how to curb the growing debt problem. It was great to hear that the President is desirous of the reinstallment of pay-go rules. This means that no tax cut or new spending program can preceed unless it is offset by spending cuts or tax increases. This was a budget tool that showed great success in the later Clinton years but funding two wars and the Bush tax cuts put it to bed. We are skeptical that this Pay-GO will see the light of day as the Liberals in Congress are already up in arms about defense spending, which is not included in the discretionary spending freeze.
Budget battles stand to be drawn out, bloody affairs as the partisan lines are drawn. As the Greek/European budget crisis plays out, we see how devastating the results of fiscal malfeasance can be. Greece is already being forced to pay very high rates relative to its neighbors for its continued profligacy. One other point that Obama raised also piqued our interest. Job growth was going to be promoted by exports. How will this come about? Export subsidies to U.S. businesses, tariffs on imports, or a concerted effort to depreciate the DOLLAR? It is one thing to promote exports but it is quite another to lay out a plan on how it is to occur, especially in an administration so beholden to union support.
While on the subject of debt, we wish to recommend a piece in today’s Financial Times by the dynamic duo of Kenneth Rogoff and Carmen Reinhart. These are two of the better academics in that they synthesize the theoretical and the practical. In this opinion piece, they warn against governments playing the yield curve by shifting debt duration to the front end where they pay cheaper rates. The problem with the DEBT load is that it eats up a big chunk of discretionary spending as rates go higher, creating havoc with all types of governing plans. The more of the budget that is used to pay interest on the DEBT, the less to spend on healthcare,education and trade promotion. This is the problem that Greece and all profligate societies confront. As Rogoff and Reinhart state:
“Although most governments still enjoy strong access to financial markets at very low interest rates,market discipline can come without warning.” They continue, “soon they will also wake up to the fiscal tsunami that is following. Governments who have convinced themselves that they have done things so much better than their predecessors had better wake up first. This time is no different.”
This wake up call will surely resonate now that the Greeks have put the issue center stage. The fact that the Chinese are questioning whether to bare gifts of money to an ailing government and the impact that Chinese wavering has had on global markets it is important to monitor all debt markets for the significant role they play in setting trading strategy. We must remember: Markets are dynamic and not static. The fundamentals that drive them are always in flux. Debt is back to on the frontline.
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