Spin it all you like, the US budget deal is a dud

Looking through the new U.S. debt ceiling deal reached at last minute, it’s a blatant political deal that is yet another egregious example of the extend and pretend meme that has dominated every financial crisis stretching back to Greenspan’s 1987 response to the stock market crash. The obvious purpose of this budget deal is to make the U.S. Presidential election a referendum on the anti-tax GOP, and the pro-tax Democrats. No more, no less.

Even during the legislative sausage-making that led up the deal, it was always only about political positioning – and never about the details. Now, the actual nitty-gritty of the deal needs to be ironed out first with Vice-President Biden and the big battle will stand in the new so-called Super Congress – talk about a contradiction in terms!

The only Super thing about this new Super Congress is the fact that the politicians are celebrating it as a victory for mankind while even a nine-year old child can see it for what it is: a way to maneuver all necessary new burden sharing to beyond the next election cycle. It’s clear that the Super Congress will not agree on anything even before the deal is actually signed into law. That’s because of the deadlock created by Democrats who don’t want to cut spending, and Republicans, who don’t want to increase taxes. Meanwhile, even the assumed savings of the deal are against a baseline scenario which increases the US debt by 10 trillion US Dollars over the next 10 years (and at that, only in the event of a projected strong growth), so the savings coming from this new plan are merely going towards reducing the “speed” of the debt creation, not actually reducing it. I guess in the minds of politicians, it’s almost the same thing – it seems they think it comforting to slow their drive towards the edge of the cliff to 80 miles an hour rather than 100 miles an hour – Voila! All solved.

The disconnect between the political debate and the ugly fiscal reality in the U.S. is unfortunately also evident across other troubled regions like Europe, Russia and Asia. This divide seems partly caused by the futile grasping at straws by the high priests of the Dismal Science, Economics. Their efforts have miserably failed to address the sickness of weak growth, debt bubbles and apathy in the political system. 

There are no “best practices” for running an economy. Yes, in times of need for speed, clearly a planned economy gets you from point A to point B the quickest, but in times of a tail-wind for growth and pain caused by past imbalances, this type of economy will allocate resources and capital inefficiently, trying to prop up a system that is no longer sustainable. A market-based economy, on the other hand, should in theory be able to allocate resources to yield the highest marginal return. So far so good.

The Federal Reserve experiment with a zero interest rate however proved to be the real test which the economic models failed to deal with. A zero interest rate policy (ZIRP) makes everything seem positive at first – as zero interest makes everything look like it can yield infinite returns. That in itself is troublesome, but what “killed” monetarism was the ability of organisations and banks to create their “own money”, money that was not measured inside the traditional monetary aggregates Think derivatives et al. That’s the real difference – the dismal science and its mainstream Keynesian assumptions, forgot to follow the old rule of thumb: If the result you get is wrong, change the premise. Changing the premise is what is needed – on the U.S. debt, on the EU debt and on reallocation of global resources.
This game of keeping scores – on a relative basis – against baselines, against untold rules, and against the consideration of election timings, desperately needs change.

The good news is that these much needed changes are happening – at least on the micro level, simply because the micro-level economies need to change to survive – the individual business or household does not have any illusion that they can ignore their mortgage and other debt payments, they simply adjust their living standards to their earnings and then move forward again. I remain extremely confident on the individual’s ability to handle crisis. But the political system and its advisors need to go back to checking their premises – otherwise they will soon be wearing dunce caps. As Einstein famously said: “if you keep repeating the same experiment and expecting different results, you are an idiot” - Einstein’s words not mine. As a variation on the same theme, there’s also that oft quoted definition of insanity: doing the same thing over and over again and expecting a different result.
In closing – we have had a negative stance on risk since Mid-May (No More Silver Bullets) but have now moved to a neutral stance.
 
The upcoming Jackson Hole Fed conference (where Ben Bernanke last year hinted at the coming of QE2), and the battle to save Europe from sovereign debt contagion, could lead to some opportunities. I would be fully satisfied if we reach our medium S&P500 target of 1200/1210 (we’re at 1245 as I write this). I am also starting to exit long fixed income as my base scenario of collapsing U.S. growth now has come to fruition. I see the upcoming downgrade of the U.S. and the marginal funding cost of Europe as key drivers into a true Crisis 2.0 – a phase where investors leave behind fixed income – and seek tangible assets of which equity should see some relative inflow.