Time to Breath a Sigh of Relief?

StockMarkets-

Good outlook? Japan’s Nikkei index was the first to open after President Obama announced a U.S. debt deal, and climbed 1.7 per cent. The expressions on the faces in the photograph convey relief and concern together.

The first market reaction to news of a possible deal between Republicans and Democrats was the Nikkei climb. It seems inconceivable that the deal will not be passed by Congress and accepted by President Obama. If the next stages falter all bets are off once again and the US would be out of time to convince bond holders.

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The initial response by markets must be a surge in confidence. The Nikkei was surprisingly restrained in only showing a 1.7% rise and it may be that all markets will not commit fully until they see the deal signed off by Congress and the US President.

Once the deal is fully signed off and the US Treasury is free to borrow more money, markets may become nervous. Although the increase in permitted borrowing is huge and theoretically able to let the US survive economically to the end of the Presidential re-election bid there are still so many uncertainties and the Euro is coming back into focus as the immediate US disaster appears to have been averted. There will also be time to see the small print on the US agreement.

President Obama will have to cut immediately by $1 Trillion and have to start work to identify a further $1.7 Trillion cuts as a condition of the increased borrowing authorization. Unless there are any attempts to modify the agreement, it appears to include a fail safe that will operate automatically if Obama fails to make both cuts. The markets will consider in the coming weeks whether the cuts are being made as required and no one yet knows whether the cuts are sufficient, or whether the US economy will be able to make do with the new borrowing levels.

If the deal fails to satisfy the markets, it is bad news for everyone, even the Chinese who still have significant reserves.

The Euro fudge to keep Greece going is already showing signs of unraveling and the crisis in Europe is far from over.

The major challenge in each area of economic concern is that the politicians still do not demonstrate that they really understand the depth of the global crisis. They give every indication that they are still playing politics and trying to avoid tough decisions. Had they faced up to the dangers more than six years ago, there would have been a number of uncomfortable periods in most national economies. By trying to avoid the decisions required then, what would have been uncomfortable is now becoming potentially fatal. The margins for error are tiny and the risks are enormous.

Because the global economy entwines national economies no one is safe. Currently China appears the most solid economy after a decade of dramatic growth. However, China is one of the largest US creditors and depends on export markets. A US default would cause significant problems in China. A stagnation or shrinking of Chinese exports would create immense social and economic problems in a country that is trying to combine two incompatible eco-political concepts.

 

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