After much political drama and a government shutdown that still persists as of this writing, it seems that a debt ceiling deal is in the making. This prospect provided much needed relief for the financial markets. Stocks rebounded 2% in just one trading day. Up until then, stocks had been declining on the potential for at least a partial default by the US Treasury. Any default on government debt can be problematic. Who can forget all the turmoil caused by the Greeks in 2011? Governmental debt has the perceived advantage that even if the government lacks the cash to make its payments, it can always print whatever it needs. This practice makes little sense to those of us who must maintain a balanced budget but is quite commonplace in government.  This practice should not be confused with borrowing to cover any shortfalls. Governments around the globe, including our own, have been feverishly printing money in an effort to ward off the effects of global deflation present since around 2000. This specter of deflation makes the debt ceiling a compelling issue. Once reached, the Treasury would, in theory, lose their legal right to continue printing dollars and getting them into circulation. The debt ceiling represents the ultimate credit card limit at something around $17 trillion dollars. At risk, in the minds of many, is a potential credit squeeze that would make 2008-9 look like a stroll in the park.

            None of us should view this potential default as trivial. While some politicians see it as a way to force fiscal conservatism on the US government, the results may be more than any of us can bear. Fortunately or not, US Treasuries provide the foundation for much of the global economy and financial transactions.  The prevailing interest rate paid by various maturities of Treasuries sets the interest rate paid by many other types of debt instruments. Treasury debt is also treated as the ultimate safe haven investment when all else is failing. Not even gold holds such a place. One possible result, being mentioned by more than one source, is a large scale disruption in the money market funds. Money market funds represent the “cash” portion in everyone’s brokerage accounts. Money market funds are relied upon to hold their value and pay some small amount of interest. Any loss of value (principal) in a money market fund is referred to as “breaking the buck” as these funds are always maintained at $1 per unit. In 2008, there was a mutual fund company whose money market fund held Lehman Brothers commercial paper (7-day loan usually to cover payroll, etc.) at the time of Lehman’s bankruptcy. The money market fund dropped to around 95¢ per unit, handing investors a 5% loss on their cash overnight. Thankfully, the mutual fund company, and industry, recognized the significance of this event and made their investors whole. Imagine a similar event playing out with US government debt rather than the commercial paper of one company. There would be no place to hide from such an event and no pockets deep enough to cover the losses. And, this is just one possible scenario. It is easy to construct many others. Suffice it to say, our elected officials in DC need to work this out in short order.

            As for the Fed, with Ben Bernanke’s term coming to a close at the end of January, the markets were relieved by the nomination of Janet Yellen as his replacement. A long-time Federal Reserve member, Ms. Yellen is viewed by most as the most “Bernanke-like” replacement available. The popular belief is that she will largely stay the Fed’s course without major changes until such time as economic conditions warrant. And according to Pimco’s Bill Gross, widely regarded bond king, this could be a very long time. In a recent article, Mr. Gross postulates that even when Quantitative Easing is over, short term interest rates will remain low for years to come. This, he states, is part of a “beautiful deleveraging” of the US economy. More simply stated, I believe the Federal Reserve realizes it cannot stand a spike in interest rates given the record balance sheet of debt it is carrying. No matter the explanation, we should all be prepared for the very real possibility of low interest rates for the foreseeable future.

            There are those, Bill Gross included, who are making comparisons between our current economic conditions and those of the late-1940’s. And, there is some basis for this comparison. During both periods, the US government was heavily laden by debt and forced to ratchet down interest rates. As interest rates slowly rose in the 1950’s and 60’s, it counter-intuitively fueled the American economy and stock market until the gold window slammed shut in 1971 ushering in skyrocketing inflation. This rally could occur again. One key difference between then and now is the state of American manufacturing. In the late 1940’s, American manufacturing was the undisputed king. Much of the industry in Europe and Japan had been destroyed by WWII while leaving the US intact and mostly untouched. I would argue that we are not in that enviable position today although cheap natural gas is helping to fuel an industrial resurgence. Time will tell if our innovation and American spirit can keep us out front.

            In the meantime, it is with no small amount of amazement that I watch events in DC unfold. I am both intrigued and disappointed that the actions and inactions of so few can reap consequences for so many with no signs of remorse in the few. We, too, have a part in this. Not only did we cast our ballots for these people, I suspect most in this country have not provided any feedback to our elected officials in a long, long time. I am included in this cohort. It is truly time to say “enough already!” and stop with the blame games that seem to be continually played. With this in mind, I ask each of you to provide polite and constructive feedback to your national, elected officials. And, I commit to do the same.

Paul Kluskowski