Today, S&P put the major countries of Europe, including Germany, on CreditWatch with negative implications for a downgrade, adding to why it will be a December to remember for investors in the stock market. At least five themes are crisscrossing: the Euro Crisis coming to a head, the Year End US Tax and Budget deal, the extension of the US debt limit in the wake of the Super Committee’s failure, the suddenly slowing Chinese economy and President Obama’s pending 17 day golf vacation.
Early December started with a manic bang up 7% off the market’s Thanksgiving lows, in part because of coordinated action by all the major central banks to stave off disaster in Europe, including the uncoordinated Chinese Central Bank announcing 20 minutes ahead of the European banks and the US Fed that centralized action was being taken to provide central liquidity not previously necessary.
Also announced was a joint Stability Pact by France and Germany designed to levitate the unloved bonds of the peripheral EU states of Italy, Greece, Spain and Portugal. The idea that 17 sovereign states will rapidly diminish their national identity by quickly adopting a constitutional “golden rule” prohibiting ongoing budget deficits with review by the European Court of Justice seems far-fetched, a little bit like Dr. Peter Venkman’s apocalyptic warning in Ghostbusters about “dogs and cats living together…” It just sounds unnatural.
Even the trial balloons to deal with the crisis sound strange. For example, last week the there was talk of a European Financial Stability Facility that would issue special bonds to raise money to buy sovereign bonds and promise investors “don’t worry: we’ll stop you out of the first 20% or 30% of your losses.” When sovereign bonds start defaulting, who can be sure that the downside is only 20%, or even 30%? Nevertheless, the key questions are, first, do the politicians of the individual countries have the room and the public support to give up their nations’ control over their national budgets in order to keep the dream of the Euro alive? And if not, can they successfully do an end run around the will of the people in recalcitrant member states? For now, the market is buying that at least one of the questions will be answered in the affirmative, but will they in the New Year? After all, all it takes to unravel the whole thing is one obstreperous country…
What has emerged from this mess is that the dollar, much maligned and over-burdened, is still the only game in town for a reserve currency for the time being. Just at the moment that the Fed has implicitly and explicitly backstopped the Euro by helping the European Central Banks, the markets will be treated to a sequel of that summer hit, “The Debt Ceiling”, which some may recall included a downgrade of US debt and set off an August and September to remember. On December 16, the United States has set the automatic timer on the printing press to turn off by virtue of the expiration of the “Continuing Resolution” to raise the debt ceiling.
Only Congress can turn it back on. The President, who has become the leading POTUS golfer since Eisenhower, has already warned Congress (i.e. Republicans) that unless he gets exactly the temporary payroll tax cut he wants RIGHT NOW, paid for with higher taxes over ten years on “millionaires and billionaires,” everyone will spend Christmas in Washington, D.C. Today, he moved the goal posts even further. He said he was confused today as to why there was even a need to “pay” for the tax cut with tax increases. It’s almost as if his next sentence will be, “C’mon guys, money grows on trees.”
There is an excellent chance that the President has overestimated how much Congress wants the President to work on his golf handicap. As the Super Committee’s failure to act shows, all of the political capital available to both sides is maximized if there is no deal until the bitter end, if there is one at all. And all of this is made worse by the fact that the European solution appears to require the US to help fund an IMF European rescue facility. That is to say, just as the US budget crisis will be coming to a head, again, Congress will be raising debt and taxes on US citizens to help pay for the rescue of Europe as well as to extend the payroll tax cut. Keep those seat belts fastened.