Markets are breaking down, all over the world. Apparently our beloved Democratic officials weren't able to save us by raising the debt ceiling. What a shock and disappointment.
This phenomenon, certainly reminiscent of 2008, has a lot to do with the interconnectedness of markets and the “global bubbles” John Authers has written about. Its proximity to the “debt ceiling” theatrics also brings to mind Barack Obama's irresolvable dilemma, which I discussed last fall. Obama wants a “recovery,” of some kind, in order to get reelected; the Treasury Department, on the other hand, requires an equities collapse. Why? Because, as we saw today, there's nothing like a massive crash to convince investors to buy all the new debt the Treasury just issued.
Barack Obama is caught in a financial Catch 22.
On the one hand, his party’s fall re-election prospects rest on the stock market consolidating its gains since March 2009 (Dow 10,000), if not rising. Since his first day in office, the president has announced that the country is experiencing a great economic “recovery,” and any serious downturn in the major indices would give middle- and upper-class Americans whiplash and be politically devastating .
On the other hand, in order to remain viable, the Treasury Department needs an equities collapse -- and probably not just a slow bleed but a dramatic crash -- in order to herd millions of investors into the U.S. dollar and government debt.
The will of the Treasury will prevail, and the president and his party will be left high and dry. Furthermore, the crash will greatly empower the Treasury and federal government … for a time.
If investors, especially the big ones like China and Japan, got the inkling that Washington were going to print its debt away (and thus cause massive inflation), then demand for bills, notes, and bonds would collapse and interest rates, soar. The government, and the currency underlying it, would deconstruct.
This perilous situation is heightened by the fact that, as of this writing, around a quarter (20-30 percent) of U.S. debt is in short-term Treasury bills, which mature in less than one year. (Clinton’s Treasury Robert Rubin (formerly of Goldman Sachs) can lay claim to developing this financing arrangement, which came to bear his name.) If the market expects monetization, then in order for the Treasury to roll its debt over, interest rates would have to be increased every three months. A classic Vicious Cycle. And rates wouldn’t actually have to go to stratospheric levels for Washington to be doomed. If they simply returned to where they were in, say, 1980, the Treasury would pay close to a trillion each year just to service its debt.
The prospects for monetization would be much improved, however, if the Treasury could lock investors into long-term Treasury debt, bonds that don’t mature for decades and which investors would have a difficult time exiting from.
This is where the equities crash comes in.
The Crash of 2008 was notable not only for the steep decline in stocks and commodities, but the dramatic increase in the demand for “cash” -- that is, liquidity in the form of the U.S. dollar as well as Treasury debt of all sorts. ...[I]n the gloomy days of November, long-term interest dipped below 1 percent -- short-terms yields went, absurdly, negative! Investors were hurdling headlong into Treasuries.