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World will pay for Congress' failure

Updated: May 3, 2013 12:14PM

Congress' failure to act on a financial rescue plan may represent the turning point in the United State's global financial leadership. While publicly arguing among themselves for petty political reasons, our elected representatives defaulted on their pivotal role in the financial structure of the world.

Now, amid ongoing turmoil, the world may decide to find its own painful solutions. And we'll look back on the moment and see its true cost.

Tuesday's huge decline in the Dow ricocheted around the world overnight, first in Asian markets and then on to Europe. It's quite clear now that there will be a global economic slowdown. Even China will face market forces, as consumer economies pull back on orders.

The stock market is just the tip of the financial iceberg -- but one that is melting down quickly. Expect more selling, since this marks the end of the third quarter for investment firms. Hedge funds will liquidate holdings to meet quarterly redemptions.

And additional selling pressure will come from the public's panic liquidation of mutual fund shares, priced after the close. In the rush to raise cash, even the "good" stocks will be forced lower.

The stock market is the traditional barometer of anxiety. But few -- and clearly not Congress -- are aware of the dire state of the global credit markets. Overnight bank lending has slowed to a trickle, as worries about counter-party risk mount. And trillions of dollars of derivative contracts made between banks may soon start to unravel.

The magnitude of the fear is measured in the gap in interest rates between the safest U.S. Treasury bills and the rates banks charge each other to borrow short. Typically the "spread" between Treasuries and Eurodollars is only about half of 1 percent. Now, it has risen to 3.5 percent -- a huge price to pay for what used to be considered risk-free lending.

Suddenly, the world isn't sitting around waiting for Congress to act. The market is pricing global assets and risks far better than a committee of elected officials could. The House had its chance to play games, "rescuing" selected groups such as homeowners facing foreclosure, or financial firms seeking capital.

Now the global markets will deal efficiently and relentlessly with the weakest players, without sentiment or remorse. Once the market determines that credit will be withheld or an asset has little value, all of the political posturing in Washington can't bring back its value.

So if the world markets manage to struggle through the coming days, Congress might just find itself irrelevant. And that's The Savage Truth.

Terry Savage is a registered investment adviser. Distributed by Creators Syndicate. Copyright Terry Savage Productions Ltd.

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