The Stock Market: What Could Go Right?


The U.S. could plunge over the fiscal cliff. But if it doesn’t, watch for a big stock market rally.


What’s the biggest contributor to global warming these days? How about all the hot air coming out of Washington?

As the stand-off over the budget continues in the U.S. Congress, the finger-pointers are vying with the doomsayers for media attention. It’s hard to say who’s winning at this stage but both are getting more than their fair share of exposure.

The Democrats blame the Republicans, specifically the Tea Party faction, for the partial shutdown of U.S. government services. As you might expect, the Republicans and their mouthpiece, Fox News, accuse the Democrat-controlled Senate and President Obama of obstructing reasonable proposals to end the dispute, all of which involve some sort of attack on the President’s health care program. So far, the public opinion polls suggest the Democrats are getting their message across more effectively.

As the shutdown grinds on, attention is increasingly focused on stage two of this drama, which occurs on Oct. 17 when the U.S. hits its debt ceiling. If Congress fails to pass legislation to raise the ceiling, the American government could be placed in the position of defaulting on its debt. That, said the Treasury Department earlier this month, would be “catastrophic” for both the U.S. and the global economies.

The Treasury hauled out its heaviest verbal artillery, raising the spectre of a repeat of 2008 if Congress doesn’t find a solution. “Credit markets could freeze, the value of the U.S. dollar could plummet, U.S. interest rates could skyrocket, the negative spillovers could reverberate around the world, and there might be a financial crisis and recession that could echo the events of 2008 or worse,” the statement said. I’m surprised they didn’t add that the sky might fall too.

Of course, the Treasury Department is part of the executive branch of the U.S. Government, with its Secretary appointed by the President, so it’s not exactly impartial in this dispute. It’s also worth noting the number of times the words “could” and “might” are embedded in the statement (six, if you didn’t go back and count). The plain fact is that no one really knows what would happen if Congress doesn’t raise the debt ceiling on time since this is uncharted territory.

Christine Lagarde, the head of the International Monetary Fund (IMF), agrees that failure to raise the debt ceiling would harm the global economic recovery and said it was “mission critical” for U.S. legislators to get their act together. But her tone was more sombre than strident. Unlike the U.S. Treasury, she didn’t warn of the possibility of another 2008 or the end of the financial world as we know it.

In fact, such a dire outcome is highly improbable, as the behaviour of the markets since the shutdown began on Oct. 1 has indicated. Yes, the Dow and the S&P 500 have had some big losing days but nothing that approaches panic territory.

The price of gold was an even more significant indication that investors don’t take the doom-and-gloom rhetoric overly seriously. In times of economic and financial crisis, gold is a traditional safe haven. That’s doubly so when the U.S. dollar is expected to decline. But what have we seen? Bullion has fallen in value. The precious metal lost US$42.50 per ounce, falling on the London Exchange from US$1,341 as of the Sept. 27 close to US$1,298.50 on Oct. 10. If we are really hurtling towards disaster, we should have seen a big spike in the bullion price.

A few weeks ago I wrote a column on the theme “What could go wrong?” in which I warned of the possibility of the Washington showdown we are now experiencing. So perhaps it’s time to turn that around and ask: “What could go right?” The answer is the Democrats and Republicans could find some face-saving compromise to end the crisis.

Stock markets would rally, consumer confidence would be given a boost as the run-up to Christmas begins, and the economy could get on with the slow task of recovery.

What are the chances of that happening? Actually, reasonably good. There are currently 232 Republicans in the House of Representatives (versus 200 Democrats). Of those, only 49 are members of the Tea Party caucus. They are concentrated in three areas of the U.S., the southwest (New Mexico and Texas), the plains states (Kansas, Iowa, and Nebraska), and the south (Louisiana, Georgia, South Carolina, and Tennessee).

In short, what we have right now is a situation in which the shrill Tea Party tail is wagging the Republican dog – and, judging from reports from Washington, the dog is becoming increasingly irritated.

Philosophically, all Republicans agree on the principles of smaller government and lower taxes. But many veteran members of the House also recognize that politics is the art of the possible and a campaign to destroy Obamacare by holding the U.S. economy to ransom isn’t going to fly. Moreover, the longer this drags on the more the party risks alienating voters in such key areas as the north-east and far west in the upcoming 2014 mid-term elections.

This suggests that a compromise in the next week or so is the most likely outcome. The possibility of the U.S. going over the cliff can’t be ruled out, of course. But my hunch is they’ll work it out and we’ll see a late October stock market rally as a result.


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