The US Debt Ceiling: Is America in danger of default?

By Sean O'Grady, Economics Editor
Tuesday, 26 July 2011

What is a debt ceiling?

As the name suggests, it's an absolute limit on national debt. The UK doesn't have one, though Budgets have to be approved by Parliament, but the US has had one since 1940, when it was set at a modest $49bn.

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How high is the ceiling?

High, by any standards. The current limit is $14.294 trillion, ie $14,294,000,000,000 – fourteen million million dollars. Even set against the largest economy in the world, it is still pretty impressive; approaching 100 per cent, the highest in America's peacetime history.

When will America run out of money?

The US Treasury say that they will run out of money to pay their debts on 2 August. That is the date when book-keeping dodges run out and the train hits the buffers. An emergency, short-term fix could avert disaster, but for now the wrangling between the President and Congress continues.

Why can't they agree?

President Obama is reluctant to cut social and health programmes. His Republican opponents in Congress, especially the "Tea Party" faction ("nutters" according to our own Vince Cable) refuse to countenance tax rises, because they would hurt the recovery. Most economists say both will be needed to fix the deficit in the short or long term.

What if the ceiling is hit?

First, the federal government's spending will be limited to its cash flow – no more borrowing. Given that the tax revenues only provide for 60 per cent of government spending it implies a 40 per cent plus cut in government spending immediately - rather more draconian than even the British austerity programme. The US Treasury would have to decide which government employees get paid and which have to do without pay. The decision point would be $23bn in Social Security payments due on 3 August, not covered by tax revenues. Bad as that is, there is a second unpleasant consequence; that the US would have to tell those investors cashing in their bonds that it cannot honour them. Such a default would send shockwaves around financial markets.

What happens then?

No one knows, as, with the UK and a few others, the US has never run away on a debt (not counting inflation).

Any good news?

The international body that represents the credit ratings agencies say that it might not treat the default as a default. The financial panic might not then happen.

Can the US pay its bills?

Yes. The American "default", unlike the recent one in Greece, say, is entirely technical. The US is in the fortunate position that it can virtually print as much money as it wants, so willing is the world still to accept US Treasury bills and bonds as "safe" assets. There are limits to that – hence the popularity of gold and the Swiss Franc – and long term the US will have to live within its means. But, for now, the Chinese, Gulf states and others are happy to hold their paper.

Long-term damage?

Potentially great. Missing bond interest payments or redemptions would mean that the credit rating agencies would downgrade the US. That would mean Americans would have to pay more interest on their mortgages and other borrowings than otherwise; it would cost them real money every month. Any sustained drastic reduction in US government spending would

German Retail Sales Surge by Most on Record

German retail sales surged the most on record in June as falling unemployment boosted household purchasing power.
Sales, adjusted for inflation and seasonal swings, rose 6.3 percent from May, when they fell 2.5 percent, the Federal Statistics Office in Wiesbaden said today. That’s the strongest increase since 1991, when data for a reunified Germany were first available. Economists had forecast a gain of 1.7 percent, the median of 22 estimates in a Bloomberg News survey showed. Sales dropped 1 percent in the year.
The German economy, Europe’s largest, is weathering the region’s sovereign-debt crisis as companies step up hiring to meet export orders, fueling consumer spending. The Bundesbank last month raised its 2011 growth forecast to 3.1 percent from 2.5 percent, citing stronger domestic demand.
“German consumers are finally waking up,” said Carsten Brzeski, senior economist at ING Groep in Brussels. “Of course, the rather discouraging track record of German retail sales is reason enough not to get overly excited. However, German consumers offer some glimmer of hope that at least the German economy is heading towards a soft, not hard, landing.”
The statistics office said this month it exchanged about 8,100 companies representing 33 percent of the sample it uses to calculate the monthly retail sales statistics. It will swap another 17 percent of reporting firms next year.
‘Significant Weaknesses’
The Bundesbank said on July 18 that the retail sales statistical series has “significant weaknesses” and last month’s decline is “without validity.”
Unemployment dropped for a 25th straight month in July, keeping the jobless rate at 7 percent, the lowest since reunification.
Metro AG, Germany’s biggest retailer, on July 26 confirmed its earnings forecast for 2011, saying it expects profit before extraordinary items to rise about 10 percent. Still, the company’s Media-Saturn household electronics unit posted its first operating loss in at least 20 years in the second quarter as sales dropped in Germany.
The threat of higher energy prices will contribute to a decline in consumer confidence in August, market research company GfK said this week. Oil prices rose 2.2 percent this month and inflation accelerated to 2.6 percent from 2.4 percent in June.
“The employment situation in Germany is excellent and provides the foundation for an increase in real disposable income,” said Jens Kramer, an economist at NordLB in Hanover. “That should support private consumption. It won’t become the main growth pillar, but it will support growth driven by demand from abroad.”
To contact the reporter on this story: Jana Randow in Frankfurt at jrandow@bloomberg.net.
To contact the editor responsible for this story: Craig Stirling at cstirling1@bloomberg.net
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Golden Era of Rock Star Traders Concludes

Money can be dull. There are only so many denominations, and only so many ways to make it. What’s interesting are the people who risk it, and over the past four decades no one has made more of a spectacle of risk than George Soros, whose Quantum fund famously bet $10 billion that the Bank of England would be forced to devalue the pound. Soros earned $1 billion on that trade and incalculable legend points.
Now, Soros is going to stop risking other people’s money. By the end of this year, his Soros Fund Management LLC will have no outside customers for the first time in 42 years. The shift concludes a process that began in 2000, when Soros stopped accepting new investments, Bloomberg Businessweek reports in its Aug. 1 issue.
Four years later he turned management of the company over to his sons Robert and Jonathan. On July 26, after months of debate, the three men decided to return the less than $1 billion of outsiders’ money Quantum still oversees and convert the firm into a family office to manage almost $25 billion for George, his family, and foundations.
There’s a two-word explanation for closing what was once one of the world’s biggest hedge funds and consistently one of the best-performing --- with returns of about 30 percent annually in its first 30 years: Dodd-Frank. The law requires hedge funds to register with the Securities and Exchange Commission and provide information about customers, employees and assets. By returning outsiders’ money, Soros Fund Management escapes that rule and the loss of privacy that goes with it.
‘Unfortunate Consequence’
“An unfortunate consequence of these new circumstances is that we will no longer be able to manage assets for anyone other than a family client as defined under the regulations,” the brothers wrote in a letter to investors.
The move completes the 80-year-old Soros’s transformation from speculator to philanthropist statesman, a role he has said he first imagined for himself as a Hungarian émigré studying at the London School of Economics & Political Science after World War II. In the past 30 years, Soros said he’s given away more than $8 billion to promote democracy, foster free speech, improve education, and fight poverty around the world.
Soros’s retreat from the stage is a marker of just how much the industry has changed --- and how much he’s changed the industry --- since he opened his first fund in 1969 with $4 million from investors and his own savings. Back then, hedge funds catered mainly to wealthy individuals and managers stayed out of the limelight. No one even bothered to track the number of hedge funds, which differ from mutual funds because they bet on falling as well as rising prices of stocks and other securities and can concentrate their money in a handful of positions.
Economic Trends
Soros -- a “macro” investor who profits from broad economic trends rather than focusing on individual stocks or bonds --- was among the first managers to give the industry visibility. The world was his casino, and after his 1992 bet against the pound, investors and governments were forced to pay attention. Whenever a currency plunged, there were rumors Soros had been betting against it. Mahathir Mohamad, the Prime Minister of Malaysia, called him a moron for profiting from the ringgit’s decline in 1997, even though Soros was buying the currency at the time.
In January 1998, Soros went to South Korea and met with President-elect Kim Dae-Jung. His conclusion after the meeting was that the country needed a reorganization of its entire economy. If South Korea made such changes as strengthening its banks and letting foreigners buy controlling stakes in its companies, he said Quantum would invest up to $1 billion in the country. South Korean stocks jumped 7 percent over the next three days.
Russian Government
Later that year, Soros published an essay in the Financial Times advising the Russian government to devalue the ruble by 15 percent to 25 percent. Investors took that as a sign he was shorting the currency, and they reckoned they should bet on its decline, too. Ruble-denominated bond prices plunged, and four days later the government defaulted on its debt. Soros lost more than $1 billion. He had owned Russian stocks and bonds--he wasn’t shorting them. His investment in Russia had a higher purpose. “He felt that if he was a beacon of investment in Russia, others would follow, and the capital inflows would transform the society,” Robert Johnson, a former Soros managing director, told author Sebastian Mallaby for his book “More Money than God.” “There’s a philanthropic side of George that started to interfere with the speculative one.”
Swaggering Exploits
Thanks in part to Soros’s swaggering exploits and returns, by 2000 hedge funds were hot. Managers such as Julian Robertson, Louis Bacon, and Paul Jones posted huge returns betting on Japanese stocks, U.S. bonds, and European currencies. Some graced the covers of national magazines and money poured into the industry from pension funds, sovereign wealth funds, endowments, and other institutions. Hedge fund assets climbed to about $1.9 trillion as of mid-2008.
After Lehman Brothers Holdings Inc. (LEHMQ) went bankrupt in September 2008, hedge funds saw more than a quarter of their assets disappear as markets cratered and clients pulled their money out. While 1,471 funds went out of business, the slump didn’t last long: Less than three years later, industry assets have rebounded to $2 trillion, surpassing the 2008 peak.
What hasn’t bounced back is blind trust in the wisdom of rock star managers. With the federal government demanding they answer questionnaires as long as 80 pages as part of the registration process, managers are getting much more scrutiny.
‘Paternalistic Trend’
“It’s a growing paternalistic trend,” said Don Putnam, managing director of Grail Partners, “made worse by overregulation and the controversy good investors like Soros attract in the market.”
Investors are paying more attention, too. As recently as 2007, managers might write a quarterly letter to discuss investment themes and report performance. Now funds including John Paulson’s Paulson & Co. provide weekly performance updates; clients want to know what’s going on. Even star managers complain that prospective customers can spend a year asking questions and doing research before handing over any cash.
Other managers have decided to go private, too, thus sidestepping SEC scrutiny. Stanley Druckenmiller, who worked for Soros for 12 years as his chief investment strategist, kicked investors out of his Duquesne Capital Management LLC last year.
In March, Carl Icahn, 75, gave back $1.76 billion, telling investors in a letter that “given the rapid market run-up over the past two years and our ongoing concerns about economic outlook, and recent political tensions in the Middle East, I do not wish to be responsible to limited partners through another possible market crisis.”
Taking Risks
Soros didn’t begin taking risks by investing other people’s money. Part of his appeal is that his biography is full of them. He was born in Budapest in 1930. When the Nazis invaded the city in 1944, Soros’s father arranged for false papers for his family and friends that identified them as non-Jews. Most of the people his father helped survived the war, Soros wrote in an essay published in the New York Review of Books in late June.
“Instead of submitting to our fate we resisted an evil force that was much stronger than we were --- yet we prevailed,” he wrote. “Not only did we survive, but we managed to help others.”
He added that the experience gave him an appetite for risk. “This left a lasting mark on me, turning a disaster of unthinkable proportions into an exhilarating adventure,” Soros wrote.
Philosophical Studies
Arriving in New York at age 26, Soros landed a job as a trader with Wall Street brokerage F.M. Mayer. He planned to work for five years -- enough time, he reckoned, to save $500,000 and return to England, where he would pursue his philosophical studies. Instead he stayed, eventually moving to Arnhold & S. Bleichroeder Advisers, where he set up the predecessor to the Quantum fund in 1969. He started his own firm in 1973.
In late 1988, after 19 years of 30-plus percent returns, Soros hired Druckenmiller from mutual fund company Dreyfus to oversee day-to-day trading so he could focus on philanthropy. While Druckenmiller was the architect of the $10 billion British pound trade, which forced the currency out of the European exchange-rate mechanism, Soros served as his coach, encouraging him to plow more money into the bet. Druckenmiller told Bloomberg News last year that Soros taught him an important lesson: When you’re sure you’re right, no trade is too big.
Technology Bubble
After losing money when the technology bubble burst in 2000, Soros involved more people within the firm in making investment decisions and turned over some money to outside managers. Druckenmiller left, together with another star manager, Nicholas Roditi. Soros said he would settle for a 15 percent annualized return, about half what the fund had posted since its start. Four years later, he made his sons deputy chairmen.
Soros hardly walked away. It was his money and, according to people who asked not to be identified because the fund is private, he has no tolerance for losses. His flagship fund has posted only one down year in its 42-year history. Soros isn’t a yeller, yet his brusqueness could prove to be even more disconcerting than a tirade, say former employees.
After an early argument with Druckenmiller over strategy, Soros gave in, saying he’d move to London and stop meddling. His parting words, according to Druckenmiller: “Now we’ll find out whether I’ve just been in your hair too much or whether you really are inept.”
Subprime Mortgage Crisis
In 2007, when his son Robert was the chief investment officer and the subprime mortgage crisis was spreading, Soros took over the management of the then $17 billion fund. Quantum returned 32 percent that year, with much of the gains coming from a rise in Chinese and Indian equities. The next year the fund gained 8 percent, when hedge funds on average dropped about 19 percent. Between 1973, when Soros started his own firm, and the end of 2010, Quantum made $35 billion in profit, net of fees, according to an estimate from LCH Investments.
Soros has been outspoken about the causes of the financial crisis. In an interview at the World Economic Forum in Davos, Switzerland, in January 2008, he blamed former Federal Reserve Chairman Alan Greenspan for “keeping interest rates too low too long” and “ignoring dangers in the housing market.”
In an interview with Bloomberg News later that year, he traced the crisis to 1980, when President Ronald Reagan and U.K. Prime Minister Margaret Thatcher came to power. During that time, borrowing ballooned and regulation of banks and financial markets became less stringent, he said.
Performance Has Suffered
More recently, Soros weighed in on his fund’s management again, according to two people familiar with the firm. This time it was to tell his sons that Keith Anderson, the chief investment officer, should go.
Anderson is the third trader, including Soros’s son, to leave that job since 2000. While Anderson was popular with employees, the fund’s performance has suffered in the past 18 months. In the first half of this year, Quantum lost about 6 percent, after gaining 2.5 percent in 2010. Other macro funds have returned 5.6 percent over the past 18 months, according to Hedge Fund Research, a firm that compiles industry data.
For almost as long as he’s been making money, Soros has been giving it away. He opened his first foundation, the Open Society Fund, in 1979, when he was managing about $100 million and his personal wealth had climbed to about $25 million. His initial focus was on funding scholarships for black university students in South Africa and providing stipends for Eastern European dissidents to study in the West.
Dissident Literature
Soros now funds a network of foundations that operate in 70 countries around the globe, everywhere from the U.S. to Montenegro to South Africa and Haiti. His money has paid for Xerox machines that helped spread dissident literature in Soviet-era Hungary, for training Burmese journalists reporting on the military dictatorship’s 2007 crackdown, and for drug treatment and early parole programs in Baltimore.
“Soros has been tremendously generous, and he’s been a courageous risk-taker in his philanthropy,” said Aaron Dorfman, executive director of the National Committee for Responsive Philanthropy in Washington. Caroline Preston, a writer at the Chronicle of Philanthropy, said Soros “has built a reputation as someone who tackles complex social issues and funds projects even if they have a low chance of success.”
Initially, Soros didn’t want his philanthropic foundations to survive him.
“The fate of other institutions has taught me that they tend to stray very far from the founders’ intentions,” he wrote in the New York Review essay. He changed his mind, though, deciding that closing the foundations “would be an act of excessive selfishness.”
Giving up philanthropy seems to be harder than backing away from managing other people’s money.
“My success in the financial markets has given me a greater degree of independence than most other people,” Soros wrote. “This obliges me to take stands on controversial issues when others cannot, and taking such positions has itself been a source of satisfaction.”
To contact the reporters on this story: Katherine Burton in New York at kburton@bloomberg.net; Roben Farzad in New York at rfarzad@bloomberg.net
To contact the editor responsible for this story: Christian Baumgaertel at cbaumgaertel@bloomberg.net
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