Two minutes to midnight–Aug 2 deadline upon us

All the bickering and acrimony in Washington might make for a good reality TV show, if one enjoys such drama and stress, but the consequences of failure in the debt ceiling negotiations are real and must be avoided.

Upbeat earnings seem to have been the one bright spot preventing additional losses in stocks last week. But the looming August 2 deadline and the drama on Capitol Hill have overshadowed any good news.

And virtually no one wants to navigate the uncharted waters of a debt default should the deadline be breached.

I suspect that if there is no agreement, and I still believe we’ll see one before Wednesday, the government will continue to make interest and principal payments and seniors won’t miss a social security check, but the chaos that would ensue would likely rattle markets even further.

But even with an agreement, numbers being bannered about fall far short of what S&P says is needed - $4 trillion in savings over 10 years – to avoid a downgrade.

Democrats want a plan that saves over $2 trillion and raises the debt ceiling by a like amount that would put off another vote until after the 2012 elections.  Republicans complain that about $1 trillion in savings is coming from the winding down of the wars in Iraq and Afghanistan - money that wasn't going to be spend anyway.

Republicans want to save about $1 trillion over the next ten years and vote again on the debt ceiling, before the 2012 elections.  They would also like to vote on a balanced budget amendment at that time.

It's not surprise why each side is offering their own separate plan.

Republicans would like to see Democrats squirm just prior to the election, when they'd likely vote against a balanced budget amendment. And it would remind voters that trillions of dollars in red ink have accumulated under Obama's watch.

On the other hand, Democrats would like to avoid another bitter display of partisanship next summer and kick the can to 2013.

Given the uncertainty the markets are dealing with, it seems reasonable not to manufacture another crisis a year from now.

Still, even with an agreement, it seems likely that at least one credit agency will void the county’s AAA credit rating. In theory, that translates into more risk and higher interest rates, especially if some pension funds and institutions, which can only hold AAA debt, are forced to sell.

But what will actually happen is unclear, and experts are divided since we’d be in uncharted territory.

Alarm bells at the Fed
The economy right now does not need higher interest rates. An early look at Q2 GDP that came out on Friday reflects the fragile nature of the recovery. And the unexpected downward revision to Q1 only adds to the uncertainty.

It’s becoming increasingly clear that Fed Chairman Ben Bernanke’s plan to buy $600 billion in Treasuries – popularly known as QE2 – has failed to boost output.

It helped lift stock prices and it exacerbated commodity inflation, but the extra money sloshing around the banking system has not helped the economy.

Unfortunately, weak job growth and a sharp slowdown during the first half of the year has Bernanke talking about another round of easing. But the evidence suggests that it would only fuel speculation, create additional distortions, and risk more inflation.