Update on the Twin Debt Fears

The summer solstice of 2011 will be remembered by investors as the day that the world’s twin debt fears, those of the United States and Greece, subsided.  What has changed?

United States

Tuesday saw U.S. Treasury Secretary Timothy Geithner state that he was optimistic that the U.S. would avert a debt default.  His confidence stemmed from an inside knowledge of the ongoing debt ceiling and budget negotiations taking place between Republicans and Democrats.

Specific details are unknown, but broadly it is thought that $2-$2.5 trillion of spending cuts is being discussed.  It is also believed that some tax increases are being discussed.

However, it is important to note that Mr. Geithner also stated, “It’s a political town in a political moment, but there’s a very pragmatic, a very realistic, very constructive spirit; and we hope that results in some compromises, the kind you need to make a broad deal work.”

In other words, factually, the only thing that has changed on the U.S. debt crisis front is that Tim Geithner is confident that a resolution will be worked out.

I also think that is is likely that a deal will be worked out.  However, without specific details, all we have is increased hope here.

Greece

In Greece its Prime Minister, George Papandreou, won a vote of confidence from his country’s parliament.  Papandreou had called the for the vote as a way of mitigating criticisms of his government’s handling of the Greek debt crisis.  Specifically, the Greek public has been furious over the proposed austerity measures (read: spending cuts to entitlement programs).

Much of the investing world, including those in the U.S., are hailing the vote as the removal of an important obstacle to a solution to Greek’s government debt woes.  However, in a 300 person Parliament, Papandreou only won 155 votes, or just barely more than a tie.  What this means is that he really doesn’t have that much breathing room.  Should he disappoint any of the members of his political faction any debt solution crafted by Europeans may be voted down.

So in Greece we also have a situation where not much has changed.

So why the big rise in stock prices worldwide?

For those of you familiar with calculus I will cut straight to the chase.  The reason for the big rise in stock prices is that the second derivative with respect to the debt crisis is finally positive.  The first derivative now has a chance to become positive soon.

For those of you not familiar with calculus what I am saying is that the fear that the debt situation will get worse is gone, instead the new belief is that it will get better (i.e. the second derivative is positive).  However, the debt crises remain unresolved, which is a negative (i.e. the first derivative is negative).

So today’s news is noteworthy.  But until that first derivative is positive there is still a need to be cautious.  I am confident that both crises will be resolved and to investors’ liking.  Yet, we are dealing with politicians, a group not above playing financial market roulette.

Jason