THE BLOG

Is Congress Taking Debt Ceiling Advice From Billionaire Who Routinely Made Huge Profits Shorting Currency?

06/10/2011 04:44 pm ET | Updated Aug 10, 2011

As readers of my writings know, I am a deficit hawk, however, I am also a pragmatic defect hawk. I believe strongly in the recommendations of last year's bipartisan debt commission, mainly decreasing our spending and increasing taxes and overhauling our tax code to cut deductions therefore raising tax revenues. Last week, I argued for no vacations, no pay, and no campaigning until the debt ceiling was resolved: in order to strengthen our economy and get out of debt, we must raise the debt ceiling. A week later, with the media focused on Weiner's stupidity and the elections of 2012, we are still no closer to solving this problem.

In fact, many more main stream Republicans are saying that a technical default will do more good than harm if it reins in spending. Whether this is political posturing for the 2012 elections or if they truly believe it is still to be seen. In either case, more Republicans have taken this stance after Stan Druckenmiller announced that he is behind it as well. While Stan Druckenmiller is one of the nation's largest philanthropists, he has made billions off of shorting currencies. In 1992, he engineered a $1 billion profit for George Soros by shorting (basically betting against a stock or currency) the British Pound Sterling on Black Wednesday, which by the UK Treasury's estimates cost the country £3.3 billion. A few months later, Druckenmiller made another $1 billion shorting the Swedish Krona.

I can't say for certain that Druckenmiller is planning on shorting the dollar in the event of a debt default, in fact he is saying that he is currently longing US treasury bonds, but he has shown a knack for betting against currencies and coming out on top. If he is using his position and influence to push a debt default and short the US dollar for his own profit, then we really should not be listening to him. We do not want to be the guy at the craps table being led on to roll the dice by the guy next to him who at the last second bets on him failing.

One may ask, "how would a debt default lower the value of the dollar?" By not paying our obligations, Moody's, Fitch, and Standard and Poor's will reevaluate and in all likelihood downgrade the US credit rating. These agencies evaluate the quality of financial instruments and debt, including US bonds, and if they see the US default on these loans they will call into question the security of other existing bonds and debts. With the deficit where it stands, the US needs to take out loans to meet all of its obligations to our creditors and citizens. Similar to an individual's credit score, a downgrade in the US credit rating will mean that creditors will be less likely to loan to the US and those that do loan will do so at a higher rate. A lack of international demand for the dollar, a drop in confidence in US debts and borrowing combined with overextension of stimulus packages and government spending will drive the down the value of the dollar.

The higher interest rates that a lower credit rating will cause will in turn raise the prime rate that the US charges banks. Raising the prime rate is a standard tactic to combat inflation, but in a stagnant economy it can have drastic effects. An increase in the prime rate translates into higher interest rates on new loans and, if you have a flexible APR, old loans and credit cards from consumer banks. In times of rapid expansion and inflation, this is used to slow down the economy for its own good, in a recession it hinders economic growth in a two pronged approach.

Businesses are less likely to borrow with higher interest rates and therefore less likely to expand and less likely to build or hire more people. Consumers are less willing to take out loans from banks on larger items and goods which in turn means less sales and less money for businesses further reducing their expansion and possibly leading to further layoffs. A farmer will hold off on buying a new tractor at a higher interest rate, therefore the tractor is not sold and the company that is making it will not make a profit off of the tractor and be less likely to continue to build more tractors.

While it is true that rising interest rates benefit lenders and savers, with US Household debt outstanding totaling $13.3 trillion (it's lowest in nearly four years), they will not be good for generating growth.

Despite corporate profits and signs that companies are stabilizing, we still see a high and fairly stagnant unemployment rate. Companies are profiting and in some cases growing, but the are not hiring more people. It can be argued that this is due to companies having one employee do the amount of work that a few years ago would have been done by two or more employees, the initial phase of a massive corporate anorexia problem.

Whatever the cause, the unemployment rate has not gone down significantly and with more people entering the work force and the Baby Boomers having to work longer due to massive losses in their retirement savings, it is not likely to do so if businesses and consumers do not spend. Add in ever rising gas prices, which in turn effect food and every other marketable good and we will have fewer dollars to spend on the things we need and have to make further sacrifices including the quality of food we eat (which would increase long-run healthcare costs), our homes and the education of our youth. Our tax dollars will go shorter distances and our economy will remain in a stagnant recession.

By allowing the country to default by not raising the debt ceiling, we are tying the hands of the American people and American businesses behind their backs at a time where we need to encourage job growth and spending.

This does not include the damage that default will do to international markets. Greece is a small player in the international level and look at the damage which that potential default is causing. A US default would ripple through Asian and emerging markets where the majority of economic growth currently is. The dollar's status as the world's reserve currency will surely be shattered, as would our economic parity and purchasing power.

Cutting the deficit is an extremely important goal, and we will need to reform our entitlements and our taxes, but it should not be done at the expense of sending us into a further recession on the advice of a man who has made his name on betting against currencies and economies. We would not stop paying our mortgage because our utility bill was too high. We need our elected officials to not pay themselves for a job they are not doing with money they don't have, and to not campaign for a future election when the real problems need to be dealt with now. They need to reach a compromise to raise the debt ceiling to encourage the economy and buy time to build a responsible budget for October's new fiscal year and the future. And we need to tell them: not at the polls in 2012, but today. Do not contribute any money to a political campaign. Sign the No Labels petition to keep the legislature at work. Write, call, email, text, moon them with a very elaborate tattoo, just contact your congressman, your senator, and your news station.

Stay tuned as my next post up is a tax compromise we can all agree on: forget about the top 1%, let's close the loopholes and get the taxes that are owed by the top 400 people.

PS: Stan Druckenmiller, if you're reading this please explain to me how the beneficiaries of your donations at the Harlem Children's Zone can take their educations and job training into a job market that is nonexistent.