Sunday 13 October 2013

All the world is made of faith, and trust, and pixie dust.

That quote from J.M. Barrie, author of Peter Pan, sums up the sentiment behind the current rally in the markets.

We are five days away from the US government running out of money, unless it is given the go ahead to borrow more. President Obama has rejected an offer of an Elastoplast (Band Aid) which would allow borrowing to continue for another couple of months. So a deal has to be made now for a long term solution. At of the time of writing no solution has emerged.

What does that mean. Lets assume that those Republicans, who are holding up the process, remain intransigent. The day will come, in the coming week, when the US Treasury is due to pay interest on its massive debt. If it has not got the cash, which it hopes to raise by issuing more bonds (best understood as  a further increase in its massive debt) it will fail to pay the interest it owes.

The US's creditors are investors and institutions around the world and they rely on the arrival of the money to pay their own debts. If interest is not paid it's as though the salary cheque does not arrive. And then a horrible spiral begins. Banks that do not have enough cash will be unable to fulfill their obligations. Bank failures will begin on an unimaginable scale. The same would be true right across the financial industry.

Will this happen? It is possible but the markets obviously think it unlikely That's why they are rising. They are probably right (as per yesterday's Churchill quote: The Americans are willing to do the right thing after exhausting all the other possibilities.) But in the mean time it really is faith, but mostly pixie dust. Remember that if the crisis is averted it is because the US Government will borrow even more. Will that money ever be repaid? Trusting that it will is where the pixie dust comes in.

Today's chart is the Vix index. Wikipedia defines it as " the fear index or the fear gauge, it represents one measure of the market's expectation of stock market volatility over the next 30 day period." It is not particularly high at present. In November 2008 it was over four times as high. But what it does show is that sentiment is currently very volatile.



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