Losing the ugly contest

SOME disconcerting news reported in today's Financial Times:Some of Wall Street’s biggest banks are preparing to cut their use of US Treasuries in August as a precaution against any turbulence that could follow if warring Republicans and Democrats fail to increase soon the US debt ceiling, a senior bank chief said.One strategy, which bank executives only agreed to discuss without attribution due to the political sensitivities related to discussing Treasury debt, is to have more cash on hand to put up as collateral against derivatives and other transactions, decreasing the financial system’s reliance on Treasuries.It's enough to make one nervous. Even if Congress managed to avoid an actual default, just treading close to the deadline could get some market participants to sell Treasuries for caution's sake, leading yields upwards and perhaps throwing markets into disarray.Of course, I've argued that as these stories become more common, there will be intense, and ultimately successful pressure on legislators to complete a deal. Besides, where are investors gonna go? Europe?Credit-default swaps on Greece, Ireland and Portugal surged to records on concern European governments’ struggles to resolve the deficit crisis will threaten their ability to pay their debts.Swaps on Greece jumped 47 basis points to an all-time high of 1,610 as of 5:30 p.m. in London after Standard & Poor’s downgraded the nation, according to CMA. Contracts on Ireland soared 27 basis points to 740, Portugal climbed 22 to 764 and the Markit iTraxx SovX Western Europe Index of swaps on 15 governments jumped 7 basis points to 218, approaching the record 221.75 set Jan. 10.These kinds of stories help to keep American yields down; American debt, to once again borrow Gillian Tett's phrase, is losing the global ugly contest.But what both of the above stories should really bring home is that the biggest risks to the global economy are political. The crisis in Europe isn't really about which economic policy choices are best; it's a debate over the future of European institutions. The same is true in America. Barack Obama and John Boehner aren't fighting over how to create jobs; they're battling over the structure of the American welfare state.If there's something scary about the potential crises in Europe, America, and elsewhere, it's this aspect: the status of economic policy as gamepiece in a broader, political conflict. That increases the odds that something big and bad may actually occur.