Fiscal Cliff: It’s a matter of confidence.
For the US government to find itself at another crisis point such a short period after the recent debt ceiling debate is astounding. In 2011, we watched as the US government debated the debt ceiling to the last hour and recklessly raised the previously unthinkable possibility of a default on Treasuries. This prompted immediate action by S&P, one of the main rating agencies to downgrade the US government to double A rather than triple A. What was previously a risk-free investment from a credit perspective, was suddenly riskier than Johnson & Johnson or Exxon according to the rating agencies. Despite the criticism from all sides about S&P’s decision, the fact is that the US government damaged confidence in its ability to act sensibly. As it happens, this didn’t have a major impact on the role of US Treasuries at the time. They were still seen as safer than anything else. In other words, risk is relative. But it did raise the idea that the US government was not as safe as everyone wanted to believe.
Today, we are back in a similar place. We’re now debating the fiscal cliff which again raises questions about the US government’s ability to manage its financial situation in a responsible way. The outcome of the fiscal cliff situation is arguably less important than the near certainty that we’re going to hit the debt ceiling again. Both Democrats and Republicans have been happy to turn a blind eye to the simple fact that for years we’ve spent more than we earn. Although an oversimplification, the Republicans get to say “but taxes didn’t go up” and the Democrats get to say “but entitlements didn’t get cut”. All the while the rest of America and the world are watching the US debt clock rise at a scary exponential rate. It’s not so much bi-partisan as bi-polar: the US spends like a big government and taxes like a small one.
This demonstrates a short sighted and arrogant approach on behalf of the US government to the privileged position the US Treasury has in the financial markets. Having the distinction of being the reserve currency and a safe haven has allowed unfettered spending and borrowing which few other entities enjoy. But the markets are no longer ignoring these crisis points and the blatant splashing about of cash that the US government can’t pay back without borrowing more. Investors globally are considering as many alternatives as possible to US Treasuries and the US Dollar. While some say no such thing exists today, the others say that financial markets are constantly evolving and frankly the US doesn’t feel that safe anymore.