U.S. Debt Crisis Enters Absurd Territory

House of Representative Speaker John Boehner, Republican from the state of Ohio, pulled out of U.S. debt ceiling/budget deficit talks over the weekend.  His withdrawal has created anxiety in investors around the world and has punctured the hopes that a deal will be reached before the 2 August, 2011 deadline.

I have written multiple pieces about the crisis, including: “Overview of the U.S. Debt Crisis,” and “Intuitive Assessment of U.S. Debt Crisis brief.”  In the latter piece, written 15 July, 2011, I stated that I felt a resolution to the crisis was around the corner and, in fact, about five days later it looked as if an accommodation was inevitable.  So what is happening?

First, I have to point out that intuition – which was just one of the tools I used to assess the crisis – simply gives a sounding at a particular moment in time.  But because decision makers have free-will, the intuitive process has to be checked in with until a certain crisis or situation passes.

So let me update that process.  To me it feels as if an accommodation is still going to be reached before the 2 August, 2011 deadline.  It feels to me as if House Speaker Boehner pulled out, not to sabotage the talks, but to ensure that some sort of accord is met (commendable) and to protect his own re-election hopes (pathetic).  It also feels as if there are strong elements of the Republican party that are more open to negotiations on the “revenue” side of the deficit talks than are the dreaded dreadnought “Tea Party” folk.

Second, I reproduced an editorial from The Economist that highlighted the absurdity of the Republican position, and I have to reiterate the import of reading that piece.  There is no reason for the U.S. to be going through this crisis at this moment.  In particular, the intransigence that the “Tea Party” is showing on the “revenue” side of the U.S. accounting ledger is asinine.

Various proposals from both political parties have included ways of raising revenues.  The one in which there is widespread agreement is to close tax loopholes, to end subsidies, and to let Bush-era tax breaks end without renewing them.  In other words, put the U.S. in the same tax situation it was under Bush to begin with – a period in which there was widespread economic prosperity and even before the heady days of the real estate bubble – yet, also tightening many tax loophole leakages.  Sounds like a genius plan, right?  Apparently, not.

Imagine your own personal financial situation if you were trying to balance your budget.  How crazy would it be for you to only eliminate expenses from your budgeting and to never factor in that you get a pay raise?  I guarantee you that the various members of the “Tea Party” do include revenue increases in their personal budgeting.

Third, I like that these talks have moved on to more substantive issues beyond just raising the debt-ceiling limit.  In an environment in which there is no looming deadline the benefits of this far outstrip the costs and I feel like this has been the primary contribution of the “Tea Party.”

However, in an environment where the deadline is the most important factor to consider I feel that it is not necessary to insist on an overhaul of the entire U.S. budgetary process when what really matters is just a procedural vote to raise the debt limit.  Why can’t the two parties raise the debt-ceiling but make it a temporary raise of only 2 months contingent on an overarching deficit reduction deal being reached by the new deadline?

Fourth, I apologize if some of you have invested money based on my assessment that it felt as if an accord was imminent.  Unfortunately, this is the nature of the investment beast.  I will point out that this situation has bad asymmetry.  As an investor, one of the secrets to making money is to identify asymmetric situations.

For example, on 12 March, 2009 when I called the Great Recession’s market low, even if I hadn’t been right about that, it was very difficult to see how the financial markets could go lower.  That is, there was an outsized chance of appreciation, relative to depreciation at that moment.

In the current U.S. debt crisis, there is actually an outsized chance of loss relative to any potential gains from a resolution.  This is bad asymmetry.  In my defense I will point out that I categorized my advice based upon individual risk preferences.  If you are a risk taker, right about now would be the time to invest.  To me, it still feels as if an accommodation is going to be reached.  If you are not a risk taker, then there is no shame in giving up some “potential” gains and instead, focus on capital preservation.

Fifth, I have been calling for a resolution to the U.S. and First World’s “living beyond its means” debt culture from the earliest days of this blog.  I am hopeful that even if the U.S. loses its AAA credit rating and blows through the 2 August, 2011 deadline without a resolution, that a substantive amount of navel gazing will take place.  In this cultural introspection it is possible that people at all levels of society explore their relationship to debt.

Sixth, and last, I consider the current U.S. debt situation to be evidence of a completely broken politic.  Government is demonstrating that it just cannot be relied upon to positively contribute to people’s lives.  Government failed us in the dot.com bubble and in the real estate bubble when Congress rolled back critical financial industry regulations.  It failed us when the Federal Reserve (a quasi-governmental institution) kept interest rates too low for half a generation leading to way too much liquidity in the economy and inflationary asset bubbles.

But folks, its not just the two political parties that are broken.  Remember that even in Presidential elections only 40-45% of voters even bother to show up to vote.  So the current situation is the by-product of a lazy or disaffected, uninvolved public, too.  What I am saying is that this entire morass is a co-created reality.  A reality created by Democrats, Republicans, voters, non-voters, investors and businesses.

Something eventually has to give; let’s just hope its not rationality, because right now it feels as if there is a bit of a self-destructive streak running through the country.

Jason