Debt Default, Interest Rates and Who Stands to Benefit

Been thinking a lot about the debt ceiling debate taking place in Washington, D.C. right now. Not discussed amidst the dire warnings of a credit rating downgrade from AAA to AA is the consideration of who stands to benefit from higher interest rates, which is what we are told will happen should the U.S. Congress not increase the debt ceiling, thereby allowing the government to go into default.

However, little guys like you and I can think this through and arrive at some interesting conclusions even as we ask some profound questions.

First, higher interest rates will impact home loans with adjustable rate mortgages (does anyone still have this type of home loan?). Higher interest rates will also impact credit card rates,  student loan rates and vehicle loan interest rates. All of this will likely add extra drag to an already very sluggish economy as goods will cost more by virtue of the higher interest rates required when purchasing on credit. (This begs the question about paying cash or not buying it if one doesn't have the cash, but that's actually a rant for another day!)

Second, and the point of these musings, is the "positive" impact higher interest rates will have on savings accounts, investment accounts and other financial instruments for the wealthier class in American society. So here it is: at a moment in U.S. history when corporations and the ultra-rich are stockpiling cash at staggering levels (rather than injecting that cash into the economy in the form of hiring, R&D and increased production), they are also now poised -- if the credit rating is downgraded -- to begin reaping greater amounts of interest on those investments.

Is this a coincidence? Or is this some kind of grand machination that some of our elected officials are complicitly engaged in bringing to bear upon the American people? Why, after all, was the debt ceiling negotiation (which is a discussion about past spending) tied to the federal budget (which is a debate about future spending)? The two issues have never been an issue before. The debt ceiling was always just raised in a pro forma manner. Under Ronald Reagan it was raised 17 times. Under George W. Bush it was raised 9 times. Never was there this manufactured crisis linking paying past debts to future spending.

To personalize it: when my husband and I discuss finances, we don't refuse to pay the bills we have incurred for past expenses (debt ceiling) because we don't like the shape of the budget for future spending (family budget). Rather, if the budget for future spending is not adequate to pay future bills we make one of two choices: either we raise revenue (by selling stuff or working more) or we cut spending (less dinners out or no new shoes). At no point, however, do we ever say we won't pay the bills we have already incurred until we are able to cut spending. The two issues are related but not necessarily intertwined.

Thus, the debate in Washington, D.C. is a manufactured crisis aimed at generating limited choices and poorly designed solutions as a way of obfuscating what is really happening to the American economy. The richest corporations and people have stockpiled vast amounts of cash in the economic fallout of the 2008 recession. Now, those same people are poised to reap huge rewards in the form of higher interest rates, thereby drawing (dare I say sucking) more money out of the average American consumer.

That's my two cents and I am sticking to it.

Reading in the Houston Airport

My flights out of the Maya world on Sunday consisted of one short hop from Merida, Mexico (2 hours) to Houston, Texas and then another longer leg from Houston to Sacramento, California (4 hours). Since I love flying, this was the easy part.

There was, however, one minor detail: an 8 hour layover in Houston in between those flights. Needless to say, I had time to kill. So the first thing I did after I got through Customs and Homeland Security was stop at a bookstore. So many books, so little time. And, after weeks of only reading about the Maya, I was ready for a change of pace. Thus, I selected Niall Ferguson's The Ascent of Money: A Financial History of the World. I made this choice partly because I had heard of the book before, but also because of the current discussions about the debt ceiling and the national deficit running through the halls of the U.S. Congress.

In terms of readability, this book is pretty appealing. Ferguson balances dense economics with fun historical tidbits in such a way that the reader is not overwhelmed with the typical graphs and charts associated with finance. He also adds some humor into the mix with the use of clever chapter titles. For instance, the chapter entitled "Blowing Bubbles" is about -- you guessed it -- bubbles in the economy. The chapter begins with an overview of Argentina but it quickly shifts to 17th century Scotland and then moves on to the Dutch and their unique contribution to global finance: the joint-stock company. Apparently in their quest to compete with Spain and Portugal, Dutch merchants strategized with the Dutch parliament to create the United Dutch Chartered East India Company. As a result of this joint venture with government, which was established in 1602, this company "enjoy[ed] a monopoly on all Dutch trade east of the Cape of Good Hope and west of the Straits of Magellen" (129). The European spice trade had begun in earnest.

Once Ferguson explains these early elements of Dutch trade and financial system, he moves on to France in the 18th century. In this case, the reader is introduced to John Law in the regency era of Louis XV. Law, among the other things that he did, "obsessively tinkered with the exchange rate of the banknotes . . . altering the official price of gold twenty-eight times and the price of silver no fewer than thirty-five times between September 1719 and December 1720" (151). This was done in a vain effort to hold off a gold and silver collapse, which came to be known as the Mississippi Bubble in honor of France's role in the early economic development of Louisiana and the Mississippi River region. Louisiana is, after all, named for France's King Louis XIV, while New Orleans is named after Louis XV's regent, the Duke of Orleans. When the Mississippi Bubble burst in 1720, "the noise of escaping air resounded throughout Europe" (154) which led to French financial problems for the next 80 years. Ultimately the Mississippi Bubble resulted in French "royal bankruptcy [which] finally precipitated revolution" (155).

The take away message here is that bubbles have consequences, although sometimes causality isn't clearly seen for decades after the fact. It's pretty clear that Ferguson gives the reader this cautionary tale about John Law and the Mississippi Bubble as a result of the U.S.'s recent real estate bubble. But before he goes there, Ferguson moves the reader into a helpful explanation of the U.S. stock market and the Great Depression of the 1930s. There are correlations to be found if one is looking, suggests Ferguson. Furthermore, "the Great Depression had its roots in the global economic dislocations arising from the earlier crisis of 1914" (160). Thus one can surmise that just as France experienced a bubble and collapse in 1720 but the social revolution didn't hit the country until 1789, so too did the global economy experience a crisis in 1914 which had a dramatic effect in 1929. And, to walk this logic down the road a bit, perhaps we will eventually look back at the real estate bubble of 2008 and realize its long term consequences on U.S. society. We are living through times, to quote Bob Dillon, that are a' changing. The question is: do we have the financial acumen to see those changes and respond to them effectively?

Of course, we cannot know the future. But a strategic person can use events of the past to inform herself about potentialities of the future. Ferguson suggests this, too, when he says "There was a time when academic historians felt squeamish about claiming that lessons could be learned from history. This is a feeling unknown to economists, two generations of whom have struggled to explain the Great Depression precisely in order to avoid its recurrence. Of all the lessons to have emerged from this collective effort, this remains the most important: that inept or inflexible monetary policy in the wake of a sharp decline in asset prices can turn a correction into a recession and a recession into a depression" (164).

The emphasis is mine to make the point. Right now our elected officials in Washington, D.C. seem to be playing a game of chicken with, arguably, the world's economy. The devastating potential for the outcome of this political game -- to raise or not to raise the debt limit -- is very high. At best, the U.S. recovery is fragile. China has a real estate bubble of their own to contend with right now and the Euro is under assault with a debt crisis brought on by Greece and Ireland. Meanwhile nearly half the world's population is living on less than $2.00 per day. Thus, if some kind of deal between Speaker Boehner and President Obama is not tacitly agreed to before the Asian markets open tomorrow (Sunday, July 24) then Ferguson's "lesson" will not have been learned and the stock market will be in for a very bumpy ride next week. I hope I am wrong, and this is just early evening alarmism. Regardless, in 24 hours we will all know whether a deal can be wrought and a roil in the markets avoided with this (inept? or inflexible?) House of Representatives.