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Wednesday, June 01, 2011 2:45 PM

Debt Ceiling Discussion on Daily Ticker with Mish, Aaron Task, Henry Blodget: Will the Bond Market Eventually Force Congressional Hands?

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In the second of three videos on the Daily Ticker recorded yesterday, please consider Debt Ceiling Vote a “Political Sideshow”, Mish Says: Real Issue Is “Govt. Spending Run Amok”

By a whopping margin of 318-97, the House Tuesday evening overwhelming rejected a proposal to raise the debt ceiling without accompanying spending cuts. The so-called "clean" debt ceiling vote was expected to fail and leaves Congress two months to reach a compromise before U.S. government goes into technical default on its debt. (See: U.S. Hits the Debt Ceiling: What Does It All Mean?)

In recent weeks, a growing number of market participants have said a technical default wouldn't be nearly as "catastrophic" as Tim Geithner and others have warned. As Clusterstock's Joe Weisenthal reports, this seemingly "out-there viewpoint" is becoming mainstream and is shared by a number of market notables, including hedge fund legend Stan Druckenmiller, bond fund maven Jeffrey Gundlach and IRA's Chris Whalen. (On Wednesday morning, House Speaker John Boehner released a letter signed by more than 150 economists, including Nobel laureate Robert Mundell of Columbia, supporting his call to only increase the debt ceiling if accompanied by significant spending cuts.)

You can now add Michael "Mish" Shedlock of Sitka Pacific Capital to this growing list.

"I would like to see the implications" of a technical default, Shedlock tells Henry and me in the accompanying video. "I think all of they hype surrounding this…is a political sideshow and nothing more."

As with the others cited above, Shedlock believes "there is no political willingness by either party to address the real issues here, which is government spending run amok."

While the Republicans are positioning themselves as the party of fiscal responsibility and austerity, Shedlock notes Rand Paul's balanced budget amendment only received 7 votes in the Senate last month. And while that was 7 votes more than President Obama's budget received, Shedlock was "quite frankly disgusted" by the lack of GOP support for Sen. Paul's proposal and fears the Republicans will "at some point in this game of chicken…give up and agree to hike the debt ceiling."

Eventually, the bond market will force the politicians to cut spending and Ben Bernanke to tighten monetary policy, Shedlock says. "All it takes is rapidly rising interest rates," he says. "It's going to happen. I would prefer it happen sooner rather than later to force the hands of Bernanke and the politicians."

By his own admission, Shedlock (among many others) has been warning about this scenario for a long time and Treasury yields have been falling of late, not rising. Still, he is steadfast in a view that cutting spending, while painful short-term, is absolutely critical for America's long-term economic viability. "People like Paul Kurgman think we should just continue on the path we're on until the economy recovers," he says. "The economy is not going to recover until you stop throwing money at it — wasting it on projects that don't need to be done."
Small Correction

I need to make a small correction to the text above. Until the official start of QE2 I was generally bullish on treasuries. I called for record all time low yields across the entire yield curve and we got it. Then new record lows in yield came on 2-year, 3-year, and 5-year treasuries just prior to start of QE2.

10-year and 30-year treasures did not come close to new lows.

That was it for me. At the end of October 2010, just before QE2 started I changed my tune and became bearish on all but very short-term treasuries.

However, we might see yet another "flight-to-safety" trade in the long-end of the treasury curve. Indeed, we may already be in one. Yields have come down substantially. This time, I am on the sidelines of that treasury rally.

Will the Bond Market Force Congress to Act?

If Congress and Bernanke continue on the current path, yields are likely to rise unless there is another serious recession, and they may rise regardless.

Spending is unsustainable and everyone but Keynesian clowns realize it. Even Congress realizes it, they just lack political will to do anything about it. Something will give eventually, or ultimately the bond market will force its will. That could be quite a ways off as Japan proves.

Session Video

A few sharp minds may have noticed this was recorded yesterday yet the discussion was on the failure of Congress to raise the debt ceiling, before the vote took place. However, It was widely understood by everyone involved that Congress would not hike the ceiling.

Mike "Mish" Shedlock
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