Our Version of a "Good, Bad and Ugly Economy"!

The question is, whether to default or not to?

How would a layman rate the present American economy? Well, it may be the job for the rating agencies-Moody, Fitch and Standard and Poor, as they are marinating for a busy schedule for the judgment day- August 2^nd. For us, it is between “Good, Bad and the Ugly”. A good economy supports lending. A bad economy does not, while the ugliest of all- defaults.

The doomsday clock is ticking faster than it seems. Prioritizing a compromising solution as a last ditch to avert a default seems to be the utmost bread and butter job for the US policy makers these days. Like the ratings’ agencies, they have a busy schedule till 2^nd of August. The next day would belong to rating agencies. What started out as fiscal hedonism has turned out to be a pauper’s austerity? Let’s see.

Financing bailout programs now have almost become 'vogue and vanity' since, behind the wax-lyrical tunes of recovery following every major recession, belies the debilitating melody of writedowns and bailout packages regenerating acute market anxieties. Following the Subprime crisis, the Fed Reserve bailed out the private sector. Now, who would bailout the US government? So, one may hang around one’s own mind and ask, what is making the economies so vulnerable to default? Are these the consequences of policy-breakdowns or outcomes of modern fashionable hedonistic fiscal practices that predisposed those same economies to adopt austerity measures at present?

For the creditors, it’s a matter of “faith”-China and particularly Japan. A default would cost at most about $4.5 trillion of creditors wealth, substantially those of China, Japan and the UK. The days of gunboat diplomacy would invariably end for China, who often mounted threatening calls for a sell-out of their enormous fed treasury holdings-but yet, that’s nevertheless hard earned currency from cheap manufacturing exports. Japan, perhaps, may have the worst pie, had run through one of the worst stagflation for decades, has been through a devastating Tsunami, and well, may loose after everything else, their proud investments in Fed-treasury. That amounts to $900bn, or about 1/5^th of Japan’s yearly output.

So, the question hovers, can Obama administration afford to default? And if they do, what would be the market reactions? Who will win or loose the largest part? This P&L accounting now seems to be both annoyance and anxiety among the investor community globally, since; the attractiveness of the US treasury bills fascinated many a countries to shelve their surplus forex reserves, as a safe haven. The US Treasury bonds are considered most liquid product in the world after hard currency, and they could have never imagined that there would be such a version of liquidity crisis in the US that would dent their faith in it. But it happened.

Again, it’s a matter of confidence and trust-the other import of faith. These countries, not only exported their goods and liquidity (as trade and current account surpluses), but together, their faith through their investments. For the US, suppose that even if they default, the equation won’t change much. It is neither Greece nor Portugal. Being an Ivy-league economy, at most, it may loose credit status temporarily and that too, people will forget after a decade or so. But the Obama administration cannot alienate the vote bank by rolling back Medicaid. Or neither the note bank-the corporate sector-by increasing tax rates.

And if they doesn’t estrange these two, the only option is to alienate the international creditors-ahoy, China! Think like killing two mocking birds with a single stone. Well, not a bad option is it? At least, they don’t have to worry about repaying Chinese debt.

So, the reason, it may become an Ugly economy-By Default.

And suppose that if there was any political motive behind buying U.S. T-debt by China, that would, again ahoy-will be nullified. But that might invoke “gunboat diplomacy”. But first in place, why did China buy so much of US Treasury debt? They found no other better place to invest and channelize their surpluses. And then, perhaps for a better U.S.-Chinese debt symbiosis that may have shaped artificially low interest rate scenario which first led to housing price bubble, and then let it burst. Now, the whole episode turned out to be some borrower’s paradise, and lender’s nightmare. So suppose that the P&L accounting goes wrong for China, what’s their option?

Think before you invest. Think again. And this usually follows every nation that goes bust. And for every creditor who lose by lending.

China can however recuperate and absolve some of the losses by heavily boosting domestic consumption, while, the US, may have indeed very little option but to stimulate and opt for more savings in future, and enforce fiscal prudence in managing deficits and debts. Well, the most lasting and hidden acumen is perhaps, after a short debt-overhang, US may be back in old business, but who knows what lingers for China? Where will they start investing their new sovereign wealth? India may be a good bet next time. And for Japan, perhaps, they won’t be able to afford to lose so much next time!

Well, this is the layman version of a Good, Bad and Ugly economy.

Ref: IHT, Bloomberg.