18 Nov 2011 Comedy or Tragedy?

Global investors and credit rating agencies alike are closely watching dramas on two world stages. The first is playing a very small stage with no audience and a limited run. The final curtain call for the Congressional Super-committee to reach their plan for cutting $1.2 Trillion from the federal deficit is just four days away, if you count the 48 hours required by the Congressional Budget Office to score it. The actors are evenly divided between protagonists and antagonists (depending upon your political point of view of course) working from the same economic script. In stark contrast, the second stage spans an area roughly the size of the southern and eastern United States, the actors are all protagonists, but in this drama each actor must work both from his own economic script while crafting a common script to save their European Union, their banking system, and their respective economies. 

Prospects for the super-committee, a microcosm of Congress, delivering an effective deficit-cutting plan to its parent bodies are dimming as the deadline draws near. Comments from aids indicate that ideology continues to trump innovation and courage. In the event of failure, automatic spending cuts kick in starting January 2013. About half of the cuts will be imposed upon the Defense Department. While all of government could stand some additional belt-tightening, the idea of forcing 50% of the cuts on a department that accounts for only 20% of the federal budget seems truly moronic, particularly during a time of war and escalating global tensions. It’s also the part of the budget that directly creates productive jobs. Job creators in communities that house small and mid-sized military bases will feel the impact early, as will private military contractors and manufacturers. So in short, automatic cuts translate into an near-immediate direct and indirect jobs killer.

Some say that what Congress does, Congress can undo. But the theory ignores the potential for significant, even catastrophic political and economic backlash such actions will have. In part due to these threats, House Speaker Boehner has said that he feels “bound” to go along with the automatic cuts. Senate Majority Leader Harry Reid this week also ruled out any change to the cuts. More importantly, the credit rating agencies are watching Congress like hawks. They have already warned that failure to make significant cuts in the deficit will almost certainly result in further downgrade to US debt. The first one had no negative impact on markets. Lawmakers may not get another mulligan.

There is another and far better possible outcome that should the committee fail in its charge, Congress could take up the $4 trillion deficit-cutting package presented months ago by former Senator Alan Simpson (R., Wyo.) and former White House Chief of Staff Erskine Bowles. Many in Congress have publically heralded the panel’s work already, so it might be just the right port in the storm. However, passage would require not 51 votes as with the super-committee’s plan, but 60 – potentially too high a bar.

As politicians weigh the consequences of failure against the almost certain political backlash of being booted by voters, they will be compelled to get the job done. Unfortunately, what seems just as likely is that ‘the job’ will look and feel pretty much like the status quo that put us in this mess. As a country we are more fundamentally divided than at any time since the 1860’s. There is a clear division between Republicans and Democrats of Big vs. Small Government. But more fundamentally, those who produce in this country and shoulder the debt have had enough of the status quo two-party system and they have revolted bringing us as a nation to a decision next November. The ability to compromise is very nearly gone.

Truth is Congress really hasn’t compromised for years. The two parties have largely passed on the sum of their two budgets (billions in excess of receipts) to future Congresses and generations to pay with political and human capital. Next November as a nation we will decide whether we will continue in the direction of European-style Socialism or return (painfully at first) to our roots of private initiative and free-market capitalism.

On a stage across the Atlantic plays a more complicated drama, but with equal significance to our global future. The European Union consists of 27 independent member states, each with its own economic problems brought on by years of recession. The primary purpose of the Union is to promote policies aimed at ensuring the free movement of people, goods, services, and capital among the member-states, much like that which exists here in the United States. Unlike the US’ powerful Central Bank, able to exert extreme monetary influence over the entire country, the European Central Bank is anemic by comparison. In the EU there is only loose central governance, taxation (for healthcare) and policy direction. Whereas in the US policymakers have complete control over the states and banking system, EU officials must answer first to their own nation’s voters and agendas.

European Banks within the member states own huge amounts of each other’s sovereign debt. Investors currently fear that if one of the member states (such as Greece) defaults the capital required of banks might be jeopardized. If for instance Italy’s largest bank became undercapitalized due to a Greek default, it could imperil the already weak economy causing investors to lose confidence in Italian bonds, driving their prices down. Italian bonds, which comprise even larger amounts of European bank capital in their declines might hazard a Spanish bank’s capital, and the dominos begin to fall.

The two largest member-states Germany and France are publically arguing over the role of the European Central Bank ECB while delays are causing investors to lose confidence in the ability of the bank and policy makers to fend off a crisis. At issue is the structuring a 50% write-off of Greek debt which is the cornerstone the latest plan. Investors seem to have no more confidence in the latest plans then they do the three that have preceded it.

According to Bloomberg, since last month’s agreement, the euro has lost 2.3% against the dollar and borrowing costs on two-year Italian government debt have jumped 1.35%. The cost of insuring against a default on five-year Italian debt using credit default swaps has jumped 23% in the period. Near term the Euro problem is one of confidence, in both the imperiled member states and the Union’s ability to ward off future problems. But the long term issues are the same as the US faces, only more difficult to fix.

The dramas are coming to a climax. Politicians unashamedly use government largess to advance their own purposes creating huge national debts that are becoming irreversible. They threaten the very sovereignty of nations both without and within. Thomas Sowell once wrote that “Socialism, in general, has a record of failure so blatant that only an intellectual could ignore or evade it.” If politicians in this country and Europe continue their use of it to their own advantages, with the full support of a blithe intelligentsia and media, and with the unconditional support of voters forced into dependence, then this drama and the one in Europe will be written into history as the world’s greatest tragedy.

Back in the 80’s Bonnie Tyler asked “Where have all the good men gone? … Where’s the streetwise Hercules to fight the rising odds? Isn’t there a white knight upon a fiery steed? We need a hero.”