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10/16/2013 2:00:00 PM
The Coastal Economist
By Marcus Hutchins


Government budget disputes, lowering spending, raising taxes, the debt ceiling fiasco, and other Congressional conflicts are beginning to get me down. Does anyone else share this; my general malaise?

"One thing we learn from history is that we do not learn from history?" Or do we? In the summer of 2011 we lived through this same type of debt ceiling shenanigans. Then, the equity markets plunged. This was a great and stimulating event for a trader such as myself. Why have we not seen the large sell-off as in 2011? Perhaps the markets learn from history?

As of this writing, we are at an impasse. Debt default seems to be looming. The Chinese are concerned. Wall Street is concerned. Furloughed workers are concerned. Corporate chiefs around the world are concerned. The Fed and other central bankers are concerned. The Treasury is concerned. The IMF is concerned. I am concerned.

Fortunately we have the reassurance of Representative Ted Yoho, R-Florida: "If the debt ceiling isn't raised, that will sure as heck be a moment. I think, personally, it would bring stability to the world markets."

I always appreciate a positive and calming voice in the midst of calamity. However, since Rep. Yoho's training and work experience is in the field of veterinary medicine, his knowledge of world markets may not measure up to the experience of those who are concerned.

So what is the debt ceiling issue all about? We first need to review the history. For this, I quote from a previous column.

"The federal government collects taxes to pay for its operations. These operations include the military, social security and other pension benefits, medicare, medicaid, and unemployment insurance. The remainder of public activities are quite small alongside these expenses. Thus the federal government is often described as an insurance company with a large army.

"Each year, prior to October, a budget for the coming fiscal year is adopted by Congress...Once approved the Treasury is given the job to fund the deficit or invest the surplus (no worries there).

"In nearly all countries, a budget is passed by law and funding is automatically approved based on the budget. Prior to WW I, this was how things worked in the U.S. as well. Back then, when a deficit occurred, Congress itself determined what means would be used to borrow funds to pay the bills. This became cumbersome during the war.

"In 1917 the task was turned over to the Treasury to fund deficits, with the requirement that there would be a limit, or debt ceiling beyond which the Treasury could not borrow. The debt ceiling procedure was put in place to comfort those in Congress at the time who were nervous to hand funding over to the Treasury.

"Since then, each time the debt ceiling is reached, Congress must pass a new ceiling to allow the Treasury to continue funding the operations of the government, even though the funding is part of a previously approved budget.

"Generally raising the debt ceiling by Congress is a quiet process which passes unnoticed by nearly everyone but the treasury bond traders like me. Since other countries simply fund a budget once it is approved, one might ask why do we in the U.S. carry on this antiquated approach to approve a budget and then re-approve its funding when the old debt ceiling has been reached? The answer to this goes outside the area of economics and into the fuzzy world of politics...

"Since the 2010 interim elections when a number of congressmen of the Tea Party were brought into power, the budget process has become quite rancorous. These new freshmen congressmen, who have a desire to shrink the government footprint, have used the debt ceiling as a tool to accomplish their agenda."

What are the economic ramifications of this type of political maneuvering?

First, we lose the output and services from those government and private sector workers who are idled by congressional inaction.

Second, our national cost of borrowing rises to some degree.

Third, the dollar loses some of its appeal internationally.

Fourth, we are the laughing stock of the world.

The first point is shameful waste. The second is redistributive in nature. Since most of our government debt is owned by ourselves (China owns less than 10 percent despite what some report), higher borrowing costs transfer money from general taxpayers (one group of ourselves) to Treasury note and bond holders (a different group of ourselves).

The third consequence, namely, dollar demise is marginally helpful. A weaker dollar can help improve domestic employment.

The fourth point deserves a comment or two. Many countries around the world are effectively shut out of the capital markets for lack of investors. In this regard, the US is the envy of the world in that our own citizens as well as countless hosts around the globe are willing to lend money to us at below inflation interest rates.

This comes at a time when we have slack employment coupled with a desperate need to rebuild significant portions of our educational and transportational infrastructure. Is it any wonder that we are viewed as foolish when we discard this opportunity through political mismanagement?

Why look at the politics when this is the "Coastal Economist?" Our economy is being driven by a devotion to a political ideology. The desire by a few to squelch the production of public goods and services, at a time when private sector demand is still well below trend, can have profound adverse effects on livelihoods and families. This is economics.

One of the complaints I have heard from some of my macro hedge fund colleagues also centers around this spectacle. These money managers reminisce about the "good old days" when one could look at economic factors, forecast various outcomes, place their bets, and win. Now, one has to forecast the politics, which, in the short run, trump the economics of any market move. Who can get the politics right?

I empathize and sympathize with this sentiment. Further, why should my trading portfolio be pushed around by a veterinarian from Florida? Come on!

(Marcus Hutchins, MA, M. Phil, Economics, Columbia University, NYC, is a former economist, treasury bond arbitrage trader and hedge fund manager. He retired to Southport in 1997 where he resides with his wife Andrea and his youngest daughter Abbey. He welcomes feedback at coastaleconomist@me.com.)



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