The debt ceiling debate in Washington is starting to weigh on the market. After a strong run up in late June and early July, the market went down last week.
The headwind is the worry that a possible default after the Aug. 2 deadline would send the market into a tailspin. While the market isn't panicking yet, it seems hard pressed to move much higher until this issue is resolved.
Neither political party wants to risk the market upheaval and political fallout resulting if the debt limit isn't raised.
Therefore, a resolution is more likely than not — just not a good one.
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This debate is tricky because it's more about the future direction of the country than just the debt ceiling. The debt ceiling debate is merely the current field of play on which one side tries to advance the ball toward ever larger government and the other side tries to move it the other way.
The real choice will be made in the 2012 election. This debt ceiling business is just a bump in the road (as far as the markets are concerned) on the way to that battle.
Here's how this debate is shaping up.
Republicans, apparently thought the debt limit, presented a huge opportunity to get spending cuts and reforms out of President Barack Obama while he's over a barrel and needs to raise the debt limit and fund the government until after the election.
However, Obama has been able use the condition of raising taxes to fend off spending cuts. For a host of good reasons, it would be political suicide for Republics to support tax hikes and Obama knows it.
This is essentially the argument Obama is making. If the Republicans won't compromise with tax hikes for the rich, they aren't truly serious about reducing the deficit. He isn't about to let the Republicans pass an "unbalanced" approach to deficit reduction that the people are against.
The White House calculus is likely that either the Republicans will cave and raise taxes (virtually assuring Obama's re-election) or Obama can use the Republican's unwillingness to raise taxes as a justification not to agree to significant spending cuts – which he never wanted to make.
The Republicans realize that substantial spending reform will not happen now. The only leverage they have left is Obama's desire to get a large enough debt ceiling raise ($2 trillion) to get rid of the issue until after the election.
The McConnell plan offered last week essentially involves letting Obama raise the debt limit without offsetting spending cuts – but with smaller debt raises that Obama will need to make two more times before the election. Obama is likely willing to deal something to avoid this arduous political situation.
The Republicans will probably press for $2 trillion in real spending cuts over the next ten years in return for extending the debt past the election. The negotiated settlement will likely be $2 trillion or less in fake and meaningless cuts.
The market will most likely accept this worthless resolution and continue to move higher – for now.
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