Markets Won't Indulge GOP Debt Threats
The GOP’s debt ceiling threat has been tried before and last time the markets were quick to shoot it down.
Way back in antediluvian times—about l995—a very successful investor and Soros Fund Management partner named Stanley Druckenmiller opined in the fall that perhaps it would be a good strategy for the Republicans in Congress to threaten to allow the United States to default on its debt in the absence of a true budget and entitlement reform package.
This opinion brought forth the wrath of Roger Altman, once a very senior official at the United States Treasury in an op-ed piece in the New York Times. In turn, Druckenmiller and another successful Wall Street figure, Kenneth Langone, fired back: “market(s) will not be unhinged by a clear movement toward a balanced budget agreement, even if it is threatened by an interest payment delay.”
Well, now. Three serious market participants. A serious dispute over strategy and market reaction. The very thing that billions are won and lost upon.
So, what happened?
On Jan. 25, l996, reporter John R. Wilke was writing, “Wall Street analyst, Stanley Druckenmiller, in change of position, says Republicans’ threat of default is ‘failed strategy….default threat would only rattle investors.’”
Wow. What possibly could have changed someone’s mind this dramatically?
Reality did.
In between the original exchange between Druckenmiller, Langhone, and Altman, a couple of things occurred.
First, on Dec. 16 of 1995, the Dow Jones Industrial Average plunged 101.52 points, down 1.9 percent. The benchmark 30-year US government bond dropped 1 17/32 points, its yield hitting 6.2 percent.
Second, on Jan. 10, 1996, according to the Washington Post: “Investors frantically dumped stocks and bonds today in reaction to threats of a long stalemate in Washington over efforts to eliminate the federal budget deficit.”
During that day, the Dow Jones industrial average dropped 97.19 points “twice triggering the New York Stock Exchange’s limits on computer-guided trading.”
For perspective, the DJIA was about 5,100 at the time. An equivalent drop today when the Dow is at 12,763.31 would be about 250-300 points in one day.
So, the United States Congress has tried the old, “we won’t raise the debt ceiling without a big fiscal plan” threat before. Its bluff was called, a couple of government shutdowns ensued, markets were rattled, and in November of 1996, President Clinton was re-elected.
Keep this history in mind when analysts and politicians assert that America’s equity, bond and currency markets will take a stalemate over the debt ceiling this year with aplomb. Markets don’t react with aplomb. They react with fear or greed.
My colleague, Jay Powell, was Undersecretary of Treasury for Finance under the Bush I Administration. He has excellent Wall Street experience. Read his analysis of the present situation, and the options open to the Treasury Department if Congress fiddles with the debt ceiling vote later this year.
One might also read entirely the letter from Matthew E. Zames, Chairman of the Treasury Borrowing Advisory Committee, to Treasury Secretary Tim Geithner on April 25. Jay’s piece links to the Zames letter, which doesn’t beat around the bush a bit.
Optimists, usually a rare bird in the Washington, D.C., jungle, believe that at least the outlines and process reforms needed to really move toward debt stabilization can emerge from the coming comedy of Congressional wrangling over the debt ceiling increase vote. Pessimists retort, “In a fight between debt in the future and Medicare and Social Security ‘cuts,’ debt has no chance to win.”
In the past, the pessimists have been right. Odds are that they will be right this time.
But no one should think the world markets will react with calm to yet another American failure to get its unsustainable debt burden under control.
Remember we tried that “failed strategy” once before.
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