Thursday the 17th, US debt limit day approaches

Last week was a strange one for the markets. At the slightest hint of a possible compromise over the US budget and debt limit being raised the markets showed their euphoric side. However, the Republican proposition to extend the time until December so that further talks can take place was actually loaded with strings attached. These strings were again around ObamaCare, so it shouldn't come as a surprise that it was rejected. What was a surprise was that the market seemed to buy into the possibility that this might work.

If anything, what we saw towards the end of last week was a relief rally. Markets had been falling off for a while and they were prepared to grasp hold of anything that might suggest a deal was just around the corner. They are still living in hope that common sense will prevail and a deal will be done by Thursday, European markets are currently treading water in wait, while the US market is currently predicted to give back some of the gains made towards the end of last week. So far a big sell off has been avoided and the US bond market is closed today.

If you are an investor in shares these are troubling times. Perhaps not so much if you are a trader. Investors perhaps don't want to think too much about liquidating everything before Thursday, but also why would anyone open any new long positions before that date? Traders, especially those with short term time horizons will probably be out and waiting or looking to get out the closer the date approaches. They will also be looking at opportunities to short in the event of no agreement. Longer term investors may also look to hedge against the fall out of share price falls by taking out an index short, the more sophisticated may be using options. Many investors however, will probably just sit tight and hope the worst doesn't happen.

We should be under no illusion as to what a US default, even if it is only technical, actually means.

The stalemate is now damaging confidence and denting the recovery, bankers at a satellite Institute of International Finance meeting in Washington warned.

“It would be utterly catastrophic,” Deutsche Bank co-chairman Anshu Jain, said. “This would be a rapidly spreading fatal disease.”

JP Morgan chief executive Jamie Dimon added: "I think it would ripple across the global economy in ways you couldn’t possibly understand.” 

http://www.telegraph.co.uk/finance/economics/10376058/US-debt-ceiling-Markets-on-edge-as-talks-drag-on.html

The fact is that to a large degree it would be entering unknown territory, but markets do tend to react to such events in a way that is entirely predictable, they go crazy. There is a good chance of a market crash if Thursday comes and goes without a decision, because this is the way markets respond to such news. It's no good trying to be rational about it, it is unlikely the markets would simply respond by staying calm.

The reality is that many of us know that any deal before Thursday does not solve the problems the US face going forward in relation to its budget and debt, it is kicking the can down the road, but this is effectively what an inflationary money system does. The can kicking can go on for a long time, because for long periods it depends on whether you are good at controlling the can as it rolls on. Ultimately issues like debt and the budget have to be resolved, but within our current financial system it will always be relative to other things, like manageable debt. To stop the can kicking in total requires a different financial system, but whether it can ever be changed in a way that isn't destructive in a horrific way until something new replaces it is a much bigger debate.

One final point about the current Republican stance in relation to ObamaCare, is that the politics of this is saying they are doing this for their voters, or middle America, but how will this constituency respond to crashing markets if they push it to the wire? As they see their investments collapse, jobs and pensions in danger, recession or depression and the US name across the world being about as bad as it could get? If they default, who would lend to the US again at such generously low interest rates? Middle America has a lot to lose from a default, which is perhaps one of the main reasons why it is believed unthinkable that Republicans will go that far. They must know what the outcome would be from default?

The market still believes that a default is unthinkable, it is as Warren Buffett recently referred to as the financial market equivalent of using nuclear weapons. Are the US politicians really prepared to do that come Thursday?