default and consequences

In the financial world, it is unthinkable that America would default on it's debt obligation. Thats why in 2011 when we were on the edge of hitting the debt limit, treasuries rose in price! The cost of going into debt got cheaper, not more expensive, when we almost defaulted! Let's be clear, nobody really thinks that a "real" default will happen, but still serious is the risk that payments get interrupted for any amount of time.

Since it is fairly unthinkable that America would default, treasuries are used in several very big important ways. Firstly, yields on treasuries are considered the "risk free rate" in economic and financial models worldwide, and are used in setting the prices of many financial tools such as derivatives. Derivatives are used by banks and large companies to manage their financial transactions, lock in prices, or prevent losses beyond a certain point.

As treasuries are so important, it is hard to come up with alternatives. Because of that lack of creativity, a default might not have a terrible impact on the treasury market. What else can banks trade in such large quantities so easily? The short term impact might be minimal, but over the long term, risk of default, or interruption would be priced into bonds, raising the yield for the buyer, but increasing the cost of financing for the seller.

If people see rates rising, that means bond positions will certainly be money losers. Pulling money out of bonds leaves pretty much two places to put them - stocks or cash. That could be a plus for the stock market, and cash getting spent would be a plus for the economy. Higher financing cost would eat into the record high corporate profit margins right now and mess with stock valuations if there is not an accompanying rise in revenue.

Those are some portfolio impacts of a default. Next post I will look at the most frightening immediate economic consequence...

Give 'em Hell, Barry

A contingent of Republicans headed to Pennsylvania Avenue for a meeting with the President. They left without speaking to the press. They avoided ANY conversation. They headed back to Capitol Hill in absolute silence.

Word is that Obama said, "No negotiation unless they reopen the government." Hmm...

Markets celebrated a potential break in the impasse today. Those green numbers could disappear with this latest development. Stock futures are pointing to a rough day tomorrow. Rumors are circulating of a sell-off in the bond market. When all confidence is lost in Treasury bonds, what else is there?

All I know to do is light a few candles, pray for world peace, and hope good sense returns to all parties. This latest development will be the break in the dam that either brings us blessed relief or drowns us all.

Systematic risk is not for faint-hearted.

Shutdown Winners

We're still in shutdown mode. As the latest created crisis continues, investors weigh the damage and look for opportunity.

The US is the largest economy on the planet (for now), and all eyes look to us for guidance. With the chaos in Washington, other leaders across the globe wonder if they should continue to follow our lead-- no, I meant example.

As this fight drags on, there is the very real possibility of the US sliding back into recession. According to the equation, GDP comes from 4 inputs:  1) capital investment, 2) net exports, 3) government spending, and 4) consumer spending. The biggest contributor to our economic growth is number 4. When we spend, business does well, the economy grows-- and round and round we go. Consumer spending accounts for about 2/3 of GDP.

While government spending accounts for a smaller percentage of our economy, it is a crucial part. Economists are now measuring the "dings" to GDP of this shutdown on a daily basis. Bigger than that, though, is the damage to consumer confidence.

Consumer confidence is the grease of our economic engine. When we see the mess each day on the news, we worry. We get concerned about our jobs and our personal economic situation. We pull back on spending.

The damage is easier to see than the possible opportunity. As this crisis drags on, the dollar slips. And other currencies rally. We know the largest portion of the return on international investments comes from the currency differences. The first part of the year, emerging markets dragged everything down. The dollar was strengthening then.

May be time to go all in with emerging?

Congress is Breaking Bad

So my hound dog, Loretta, woke me up at 5:30 this morning. As we brewed our morning coffee, my husband said, "Do you think we're shut down?" My response? "Without a doubt." With that, we retired to our warm bed and cranked up Netflix.

Congress appears badly broken, and we just couldn't bear another hour of analysis and hand-wringing. We're in season 3 of the popular show, Breaking Bad, and it seemed a better use of our time to watch fictional criminals and their antics versus watching the real thing. We decided to forego morning TV.

On Monday, the stock market dropped significantly in anticipation of the deadline. Investors already knew what DC was going to do. The shutdown was written in each index in red ink. On Tuesday, markets headed back to green once the inevitable happened.

The length of the stalemate will determine the damage to this quarter's GDP. Of course, we may not even know what the GDP is if we can't get the statisticians back to work! Friday is the day for monthly jobs numbers-- a much anticipated event. After watching the trend in weekly numbers, we were certain they would be good. That piece of data may remain a mystery.

In the long-run, the market will brush off the latest fight in Washington. Business is business, and things will move on. But in the short-run, the crazy play-by-play in Congress will result in plot twists and turns for investors.

I think I'll avoid all news until the whole thing is over-- maybe sometime next Spring. By then, I should be in the final season of Breaking Bad. Better to be entertained by scary criminals than scared to death by the entertaining clowns in Congress!

Bermuda Blues

The Academy of Business Education had their annual conference in Bermuda. It was such a burden for me to pack up my Bermuda shorts and head to the island for a cool, summer breeze. When all was said and done, though, I decided it was a nice place to visit, but I wouldn't want to live there.

Don't get me wrong! It's breathtakingly beautiful. The island was created by a volcano. It is long and narrow with fish hooks of land masses at either end. The result is a set of protected beach coves with rock sculptures in the water. Stunning!

 



The temperature is perfect! Highs in the low 80s and lows in the mid-70s. What's not to like? Right?

There are only about 65,000 permanent residents on the island, and there is nothing (and I do mean nothing) nearby. Everything is incredibly expensive. All goods must be shipped in. Real estate is mostly inherited. Buying your own property requires millions. You either work for the government, or you work in the resorts. Opportunity is limited.

Each household is limited to one 4 cylinder car. Many people travel by scooter. Gasoline is about $9 a gallon. There are only 3 main roads on the island: North Shore Road, South Shore Road, and Middle Road. They are narrow, with some bordering on the wall of someone's house or garden. Traffic is always brisk. Sidewalks are almost nonexistent. Rental cars are not available. Travel by bus or ferry is the main option for getting around the island. We didn't realize how spoiled we are!

So, we were glad to take that flight back across the water to the good ole USA. We came back to big grocery stores with reasonable prices, gasoline just over $3 a gallon, and two cars in our garage. How decadent we Americans are!

Final GDP numbers for the second quarter came out this morning. They were a tepid 2.5%. Weekly unemployment claims continue to fall. So, it's not great news, but it's improving news. And I'll take slow in the US over Bermuda any day!