Chris Kuflik - ScotiaMcLeod Montreal

There is currently a dangerous game of chicken being played on both sides of the Atlantic Ocean. The debt-ridden United States government is now flirting with the federal debt ceiling of $14.3 trillion. The European periphery sovereign debt problem, the PIIGS, which surfaced last spring, has once again been thrust to the forefront. This time, Ireland is reluctant to accept a bailout from the EU.

America is currently playing a dangerous game of “chicken” with its national debt. Its debt ceiling, the total amount that the federal government can borrow by law, currently stands at $14.3 trillion. The total federal debt is currently $13.7 trillion. This ceiling could be attained by the spring, unless large scale spending cuts are undertaken quickly. The solution in the past has been for congress to approve increases.  Without raising the ceiling, America could be forced to default on the interest on its Treasury bonds, bills and notes. Should the US default for one day or even if markets feel there is a possibility of default, the following brutal scenario could occur:

-    They would lose their AAA rating and be forced to pay higher rates on  debt.

-    Selling would be furious and cause both US fixed income and equity markets globally to plunge.

Why is this year’s Congressional raising of the debt limit different than others? Recall that many recently elected Republicans and Tea Party officials campaigned on debt reduction and reduced taxes and spending. They will be forced to either go back on their word or risk financial calamity. While this is not the first time US politicians have shut down the government, Bill Clinton did it in 1995, this time would be different as the US economy and many investors’ psyches are much more fragile today. Bruce Bartlett, the deputy assistant secretary for economic policy at the Treasury Department under President George H.W. Bush, recently stated, “You introduce even the tiniest little bit of doubt into the minds of ultra-conservative investors and that’s potentially disastrous. It hurts our ability to raise money without a risk premium.” A filibuster accomplishes the same result as not passing the bill to increase the debt ceiling before it is reached: the government goes into default. Let’s hope that the US politicians do not continue this dangerous game of chicken.

Another game of ‘chicken’ is currently taking place in Europe which has made markets skittish over the last week. Irish banks are depleting the collateral they need to secure emergency funding from the European Central Bank. The danger is that if Irish bankers wait much longer to accept a bailout, they will probably need one by mid 2011, and that their banks may not have the necessary collateral to get aid when they really "need" it. Officials from the EU, IMF and the ECB have decided to begin accessing the balance sheets of the Irish financial institutions in an effort to determine whether or not Ireland will need assistance (in the form of a rescue fund) to avert a full blown crisis. While Europe has made it clear to the world that they are ready to help if Ireland can't solve the issue itself, Ireland should accept the external support. The Irish stubborn game of chicken is causing confidence in the European banking system to wane.

While these problems are not insurmountable, political leaders must act quickly to resolve them. Solutions, not grandstanding, must be adopted as even the hint of these troubles coming to the forefront could damage this fragile recovery. There are investments that will likely do well in this possible chaotic environment. We will remain agile and continue to employ stop tight losses to protect our capital.

On a personal note: I am currently out of town attending the funeral of a childhood friend. Should you have any questions, please contact a member of my team for assistance.

Please feel free to share this article with someone you feel could benefit from its contents.

Chris Kuflik

Associate Director, Wealth Management

Wealth Advisor

514-287-2931

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