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U.S. fiscal showdown like ‘two nuclear submarines hurtling at each other’

These are stories Report on Business is following Friday, Oct. 4, 2013.

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Clear and present danger
The partial shutdown of the U.S. government entered its fourth day with no end in sight.

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And while the markets are taking Day Four in stride, there are mounting economic costs and, worse, growing fears as the deadline for raising the U.S. debt draws closer.

"The high stakes gamesmanship is having a very real economic consequence," chief economist Douglas Porter of BMO Nesbitt Burns warned today.

"A conservative estimate suggests that every week of the shutdown will carve at least 0.1 percentage points from [fourth-quarter] GDP growth," he added in a research note.

"We are now assuming that with no clear route out, the shutdown will drag on past mid-month, and have thus cut our Q4 growth forecast 0.5 percentage points to 2.5 per cent. Suffice it to say that we are still honing the axe, in case the drama deepens and pounds investor, business and consumer confidence (beyond the glancing blow so far).

For Mr. Porter and other observers, the greater fear is what happens after Oct. 17, the day the U.S. government says it will be exhausted if the debt ceiling isn't raised.

This raised fears of a default, which the U.S. Treasury warns could be "catastrophic."

"The antics in Washington lend themselves so very well to an elaborate game of chicken," Mr. Porter said in his report, titled "Shutdown: Clear and Present Danger," a reference to the Tom Clancy novel and movie of the same name.

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"Except in this case, it's two nuclear submarines hurtling at each other, where we're not quite sure who's in control of one of the subs."

So far, Mr. Porter noted, investor aren't in panic mode in the confidence that "one side will stand down, or that Treasury still has some options up its sleeve to avoid default."

There's an interesting element here, as well, as Mr. Porter and others have cited: The 14th Amendment of the United States suggests the U.S. cannot default. The Treasury Department rejects the idea of trying to interpret and use this amendment, which actually says is that "the validity of the public debt of the United States, authorized by law, including debts incurred for payment of pensions and bounties for services in suppressing insurrection or rebellion, shall not be questioned."

Some observers believe the stalemate will end before Oct. 17, but will cost the markets.

"That would mean at least another week of uncertainty, which will probably keep the U.S. equity market on the back foot," said Jessica Hinds of Capital Economist.

"Indeed, the debt-ceiling crisis in July and August 2011 was accompanied by sharp falls in equity prices."

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Yesterday, the Treasury Department issued a harsh warning, which raised questions among some as to why officials were raising fears such as this:

"A default would be unprecedented and has the potential to be catastrophic: Credit markets could freeze, the value of the dollar could plummet, U.S. interest rates could skyrocket, the negative spillovers could reverberate around the world, and there might be a financial crisis and recession that could echo the events of 2008 or worse."

Not that a default wouldn't have that severe an impact. It's whether or not it could come to that.

"Notwithstanding the uncertainty over how long the government may be shut, the U.S. Treasury may have more negotiating room than is apparent from Treasury guidance that the debt ceiling will be hit on Oct. 17," said Derek Holt of Bank of Nova Scotia.

"That's because the Treasury's math doesn't appear to take full account of the savings associated with the partial shutdown, nor does it fully consider the large roughly $30-billion cash position on hand at the Treasury," he added.

"There are large bill maturities coming, but they can be rolled over without breeching the ceiling. That puts the focus on a $6-billion interest payment on Oct. 31."

Swiss currency probe
Swiss regulators have launched a probe into several institutions in connection with what they say was possible manipulation in currency markets.

The Swiss Financial Market Supervisory Authority gave few details in unveiling the investigation today.

It named neither banks nor currencies, and no allegations have been proven. Major Swiss banks would not comment.

"FINMA is currently conducting investigations into several Swiss financial institutions in connection with possible manipulation of foreign exchange markets," the regulator said in a statement.

"FINMA is co-ordinating closely with authorities in other countries as multiple banks around the world are potentially implicated."

This follows an investigation announced in June by Britain's Financial Conduct Authority into the issue, manipulation of foreign exchange rates used as benchmarks.

It also could be another black eye for the banking industry in the wake of the financial crisis and other scandals, such as that over manipulation of key interest rates.

While the Swiss regulator gave no details, past reports by Bloomberg News have centred on what is known as a "fix," which pegs the value of a currency at a certain time of day and is used as a benchmark.

The Bank of Canada, for example, has a noon fix. One of the major ones is that by WM/Reuters.

Last August, Bloomberg reporters Liam Vaughan and Gavin Finch published an investigative piece that looked specifically at the U.S. dollar-Canadian dollar exchange rate, and how the value of the former climbed by 0.6 per cent against that of the latter over the course of just 20 minutes in the run-up to a 4 p.m. fix in London, the most widely watched measure.

There was no mention of the Canadian dollar by the Swiss regulator, and, indeed, it was just one of the currencies mentioned in the original Bloomberg report.

Canada's bank regulator, the Office of the Superintendent of Financial institutions Bank of Canada, said it's "aware" of the Swiss probe, but refused further comment, The Globe and Mail's Barrie McKenna reports.

"OSFI maintains ongoing relationships with the financial institutions we supervise and with our regulatory peers in Canada and other jurisdictions, but we do not publicly discuss our supervisory work," spokeswoman Annik Faucher said.

The Bank of Canada would not comment.

BlackBerry remains below $8
Shares of BlackBerry Ltd. continue to trade below $8 (U.S.) as questions and speculation abound where the proposed bid by Fairfax Financial Holdings Ltd. is concerned.

The stock was up slightly by 11 a.m. ET at $7.75.

The market appears to doubt whether a Fairfax-led consortium will actually complete a deal at the proposed $9 a share, or $4.7-billion, despite the suitor's repeated optimism.

In a report yesterday, Bank of Nova Scotia analyst Gus Papageorgiou laid out a price range of between $8 a share and $13.20, in a 50-50 scenario, for a takeover of the smartphone maker.

"We have revised  our probability assumption to a 50-per-cent chance there is a competing bid and the company gets taken out at $13.20," he said.

"However, if there is no competing bid the  Fairfax offer could go lower, simply because Fairfax will be the only ones at the table. We believe it could go as low at $8. Going too much lower would eventually drive some form of competing bid."

And today, CanaccordGenuity's Michael Walkley continued to put a target on the stock of just $7, based on a "sum-of-parts" valuation.

"We maintain our belief BlackBerry will ultimately end up selling the company due to the difficult competitive smartphone market and low probability BlackBerry 10 can return BlackBerry to sustained profitability, even despite planned deep cost cuts," he said.

"Further, while we believe the most likely exit strategy for BlackBerry remains a sale to Fairfax Financial, we anticipate a lower revised bid post additional due diligence will be required to secure full institutional investor funding for Fairfax's proposal."

Bank of Japan holds steady
The Bank of Japan held the line on policy today as it cited an economy that is healing modestly.

"Japan's economy is recovering moderately," the central bank said.

"regarding risks, there remains a high degree of uncertainty concerning Japan's economy, including the prospects for the European debt problem, developments in the emerging and commodity-exporting economies, and the pace of recovery in the U.S. economy," it added.

Derek Holt and Dov Zigler of Bank of Nova Scotia say they're not as optimistic as the Bank of Japan.

"The bigger questions concern how the economy will respond to a proposed sales tax hike next year - and if the BoJ might need to accelerate the pace of its purchases to both cushion the blow and more generally to ensure that the economy continues to reflate," they said today.

"Further, the way in which the BoJ is achieving the end to deflation is disconcerting to us as it is due to higher imported energy prices partly due to yen deprecation and higher electricity prices stemming from shutting down the country's nuclear reactors."

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About the Author
Report on Business News Editor

Michael Babad is a Report on Business editor and co-author of three business books. He has been with Report on Business for several years, and has also been a reporter and editor at The Toronto Star, The Financial Post and United Press International. His articles have appeared in major newspapers around the world. More


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