Higher Margin on Swaps Just Tip of Debt Ceiling Icerberg

Higher Margin on Swaps Just Tip of Debt Ceiling Icerberg
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CME Group announced yesterday that it will raise margin requirements for over-the-counter Interest Rate Swap portfolios by 12 percent over four days as a result of the debt ceiling debate.

We noted here earlier how the debt ceiling debate damages the economy and pointed out how the last time we went through this CME Group rose margins and increased the "haircuts" (reductions in the value of collateral posted as margin) it placed on collateral posted at the clearinghouse. When they did this in 2011, they did not directly tie it to the debt ceiling debate, though it was clear that it was what drove it. This time there was no such pretense.

The CME Group notice did say that the move was temporary and subject to review but with a potential deal only extending the debt ceiling out until February you would expect them to keep the higher margins until a more permanent solution is reached.

Higher margins do create a drag on the economy because that additional 12 percent means there is 12 percent less capital able to be put to use elsewhere in the economy. And not because of a prudent assessment of organic risk but risk created on purpose by Congress having a temper tantrum over a fight it already lost.

This is what I mean by real damage. And even though, in this case, the affect may be temporary, the notion that the full faith and credit of the United States can be used by its leaders as a political pawn does affect our ability to sell Treasury products to foreign investors and for the world to use the U.S. dollar as a settlement mechanism.

I noted here earlier that the reserve currency status of the U.S. dollar is a matter of degree and each time we put foreign investors through this drama they will be more likely to look for alternative settlement mechanisms.

Investment guru Jim Sinclair pointed this out in an interview I did with him a year and a half ago. Here is what Sinclair recently said in a letter to readers of his MineSet website:

I can post all the dire warnings from every parts of the globe concerning the possibility of a default on US debt. You have seen them all, and heard all the analysts screaming bloody murder.

What no one is focusing on is the impact on future dollar sovereign investment appetite because of another close call at a default in light of next fiscal year borrowing. The US budget office yesterday forecasted 2014 borrowing at $777 billion. We know that government estimates of borrowing always seem to rise for exogenous reasons. We can easily anticipate borrowing another trillion in fiscal year 2014.

We have to ask ourselves from where are these funds to be borrowed by the USA coming from as there is an argument that people are becoming seriously dollar shy. That argument is supported by the TIC report where foreign demand for US Treasuries is way down, and on some reports negative.

The fact that things have gone as far as they have will make sovereign investors dollar cautious at a minimum and dollar phobic by some.

Today Sinclair pointed out a commentary on China's official news agency where they suggested the world should consider "de-Americanizing." It stated: "As US politicians of both political parties (fail to find a) viable deal to bring normality to the body politic they brag about, it is perhaps a good time for the befuddled world to start considering building a de-Americanized world."

The suggestion should not be a shock to anyone. It is not a far stretch to suggest that at least some permanent damage has been done and damage is accruing as this goes on. It would be naïve to think that a deal gets done and everything just goes back to normal.

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