The Fate of Inevitability

Well, that was interesting!

Congress raised the debt ceiling yesterday, while stocks fell through the floor. The Senate voted “Yay” on the legislation, then passed it off to the President for his signature.

Washington was pleased with itself; Wall Street…not so much.

While our elected officials spent the afternoon applauding themselves for their “historic” performance on Capitol Hill, investors were hurling rotten tomatoes. The Dow Jones Industrial Average plummeted 265 points, the S&P 500 slipped into the red for the year, and the gold price rocketed $38.10 an ounce to a new record high of $1,638.40.

The debt ceiling vote probably did not inspire all the selling on Wall Street yesterday, but it certainly did not inspire any of the buying.

Our elected officials demonstrated once again that they are good for nothing (approximately), even on their best days. Not even the “revolutionary” Tea Party contingent could make a visible imprint on the ultimate outcome. It’s not their fault; it’s nobody’s fault in particular; but it’s everyone’s fault in general.

It is the fault of inevitability.

Democracies vote themselves perks and entitlements they cannot afford…until they go bankrupt. Empires, likewise, gorge themselves until their economies become starved for self-sustaining productivity.

So what hope is there for a democratic empire like America?

The Fates will not be denied. America will grow fat and happy until she cannot lift herself out of her La-Z-Boy to punch a time clock. She will vote herself perks she cannot afford until the day her creditors say, “Enough!” Her fate is certain; the day is unknowable.

But to get an idea what sort of fate may be coming our way, let’s cast a glance across the Atlantic.

While the U.S. stock market was tanking yesterday, bond yields around the periphery of the eurozone were soaring. (I.e., bond prices were falling). The PIIGS bond markets seemed to be saying, “Hey, if the U.S. cannot pass meaningful, debt-reducing legislation, what chance do we have?

”Good question.

The U.S. can always print its way to a kind of solvency. The eurozone nations cannot…at least not yet. (We have predicted – and continue to predict – that the drachma, escudo and punt will return to the stage within the next two or three years.)

Greek bond prices have been tumbling for weeks – pushing short-term yields above 30%.  But that’s old news. The newer news is that yields are also soaring in the relatively solvent nations of Italy and Spain. Two-year yields in these two countries are now rising faster than yields in Greece.


Admittedly, two-year yields in Spain and Italy are nowhere near Greek yields. But the trend is not comforting. And that’s not all…The very newest news is the nascent panic in the core of the euro zone. The chart below tells the tale.


The price of five-year credit default swaps (CDS) on French government debt have rocketed higher during the last few days, which means that investors have become increasingly concerned about the credit worthiness of the French government – a AAA-rated credit. (CDS, as regular readers know, are a kind of insurance against a default.  The greater the perceived risk of default, the higher the price of a CDS).

At 122 basis points per year, the French CDS price is still nowhere near the price of a comparable Greek CDS – 1,722 basis points – or a Portuguese CDS – 962 basis points. But the French CDS is much more expensive than that of any other AAA-rated sovereign credit.

Soaring bond yields in Spain and soaring CDS prices in France are not necessarily cause for concern; but neither are they license for complacency.


Eric Fry,
for The Daily Reckoning