It is extremely difficult to get two teams to compete for the championship trophy, when one team is assured victory if they decide NOT to play. That's how it is for the republicans. The GOP is awarded the grand prize of no tax hikes and $10 trillion is spending cuts over the next decade-and as an added bonus not a penny increase in the debt ceiling-if they decide not to compromise at all with the democrats. If there is no deal reached by August 2nd, the republicans are automatically granted everything they want and more. Therefore, as I stated a few weeks ago, the consummation of a deal will be much tougher than anyone expects and the chances of no deal at all are highly significant.

Perhaps that is the true message of the bond market. Everyone is puzzled as to why yields are quiescent when there is a supposed to be significant risk that the U.S. will default on its obligations in a matter of days. But, if there is no deal on August 2nd, bond prices will rise and yields will fall; contrary to what Timothy Geithner and the rest of the fear mongers would have you believe. That's because our government will be forced to pay interest on the debt and make cuts elsewhere in the budget. The dramatic reduction in debt supply will force prices higher and yields lower. In addition, capping the total amount of outstanding debt at $14.3 trillion will serve to boost the confidence of our foreign creditors in the notion of long-term U.S. solvency, thus making Treasury ownership much more appealing. Maybe that's not such bad news after all.

Michael Pento

Euro Pacific Capital
Senior Economist/Vice President Managed Products
800-727-7922 ext. 144


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