Kicking the Can Further Down the Road
When we, at Hennion & Walsh, consider that Washington is currently considering increasing our self-imposed debt ceiling to allow the U.S. to issue more debt to service existing debt already outstanding, we can’t help but think that we are just “kicking the can” further down the road. Recognizing that our vaunted AAA credit rating is at stake and a default, of any magnitude, on our debt could be expensive and felt across the globe, raising the debt ceiling strikes us as yet another short-term remedy to put a band-aid on a mounting fiscal deficit as opposed to taking the initial steps towards building long, lasting fiscal reform. Austerity measures (i.e. spending cuts) are always difficult, and do not provide the immediate relief that many are looking for but, in our opinion, need to be considered before the debt ceiling is raised once again (it was raised to its current level of $14.3 trillion as recently as February 2010).
Regardless, we believe that an agreement will be reached on some form of an increase to the debt ceiling, perhaps lower and shorter in term than many Democrats are hoping for, in advance of the August 2nd deadline. After the agreement is reached, and the Presidential election cycle begins in earnest, the focus will then shift towards whether or not increases in revenue or decreases in spending, or some combination thereof, will be the best cure for the balance sheet woes of the United States.
The “kicking the can” further down the road analogy can certain apply to the debt crisis that is currently engulfing Europe – notably the “PIIGS” countries – as well. The PIIGS countries include Portugal, Italy, Ireland, Greece and Spain and are grouped together by many analysts because of their similar high levels of debt and spending. None of these countries have escaped the headlines over the past year with Greece occupying most of the media’s attention given their two large-scale bailouts and the civil unrest and riots that have occurred in their streets.
While a sovereign default in any one of these European countries would not have a lasting or consequential impact on the capital markets as a whole, the real risk here, in our opinion, is the contagion effect that could spread to other larger European economies should the default not be contained to any one or two of the smaller economies. While U.S. banks do not have significant exposure to the countries in question, they do have exposure to larger European banks, whom themselves do have exposure to these countries. Hence, secondary risk does exist for the U.S. which could translate to another breakdown in the global economic machine if credit starts to dry up again.
The European Union (EU) Member Countries
The EU is a political and economic community of 27 countries established by the 1993 Maastricht Treaty.
5. Czech Republic
22. United Kingdom
23. Portugal* (#37 ranked world economy)
24. Italy* (#7 ranked world economy)
25. Ireland* (#38 ranked world economy)
26. Greece* (#28 ranked world economy)
27. Spain* (#9 ranked world economy)
*The “PIIGS” countries
Sources: www.eucountrylist.com and Seeking Alpha, “Why the PIIGS Crisis Matters”, April 28, 2010.
The situation in Europe is complicated by the common currency; the EURO, and associated multi-country governing committee of the 27-member country European Union (EU), that we would argue limits the ability of the underlying countries to react to their own respective economic issues. However, based on information currently available to us at Hennion & Walsh, we do not believe that the contagion risk will manifest itself into a global crisis as the EU will likely follow a similar path to what is being considered presently in the U.S. by addressing the immediate fiscal need through the issuance of more debt and loan assistance. While this solution may just push an inevitable country default to a future date (Ex. Greece), it will allow the EU much needed time to work through the issues in the other PIIGS countries and minimize the previously discussed, and feared, contagion effect.