I spent an hour on the phone yesterday in a conference call with James Marple, senior economist with TD Bank. Here are my notes. They’re rough… I haven’t polished them up, but it gives you a pretty decent overview of what he views with regard to deficits, debt, and the current debate.

Bullets:

Overall: GDP revised downward from Q108 today, showing recession far deeper than they knew. Revisions resolve mystery between job loss and GDP numbers. Housing market still a drag on the economy, but is mostly a legacy indicator at this time. Best deficit reduction scenarios would include tax and entitlement reforms to raise revenues with spending cuts in the future to avoid a double-dip or slower growth.

Debt ceiling: No historical precedent for what is happening now, which means predictions are not concrete. 4 possible scenarios, best to worst:

Congress comes together, agrees on bill for long-term deficit reduction. Would cause rally in markets, undo pessimism priced into them right now. Congress does a deal but doesn’t agree to enough deficit reduction to satisfy ratings agencies. If one ratings agency downgrades (e.g. S&P) probably not long term effect, but would pressure policymakers to come back to the table for further reductions 8/2 no deal, interest payments met but the rest of spending cut in half. If only a few days, expect interest rates to rise by at least 25 basis points. Risk of downgrade would be priced in, would cause a 1-2% drag on GDP in Q3 2011. Longer it drags on, the higher the risk of second recession, but slow growth inevitable. Would force all non-interest spending to drop by 50% which is what would cause economic drag. US treasury misses interest payment due to revenues not there or an error in estimates of revenues coming in could trigger nightmare scenario with immediate downgrade, 2008 repeated.

In response to caller questions:

14th amendment scenario: Does not alleviate uncertainty, exacerbates it because even though there is no default and possibility of being tied up in court/partisan battles instead of dealing with deficit reduction Clean bill with agreed-upon framework but not actual bill reducing deficit: Best case: reduces uncertainty in markets, reduces political risk, but doesn’t cure issue of deficit reduction. Not a terrible outcome but not desired either. The broader question in all of this necessitates clear gesture to fiscal consolidation — tax reform and entitlement reform with latter in out-years, revenue increases sooner. With housing market uncertainty already looming, slow job growth looming, essential to factor out as much uncertainty as possible. Markets need policymakers to make good-faith effort to address both in immediate fashion. What happens to precious metals/oil futures if no deal? Gold will be safe haven until a deal is struck, then it will drop precipitously. Oil, other commodities will depend on dollar reaction. How to calm people down? Biggest fear is uncertainty driving people to make run on the markets, banks which could trigger a depression-like scenario. Important to repeat that default is a highly unlikely event and will not happen even if 8/2 deadline passes. Even if there were a default, it would be viewed as a technical default due to political dysfunction rather than systemic. Interest payments will be made, and as long as that happens, no panic is necessary. Policymakers will not allow brinksmanship to that degree, and should remember that any rise in interest rates increases the deficit. Aren’t issues larger than the deficit and debt ceiling? Yes, clearly there are larger issues but the debt ceiling is now driving the debate. Biggest issues: growth isn’t large enough to drive down unemployment rate, but challenges are temporary and related to political risk. Housing market is legacy issue. Savings rate is up, worst of deleveraging cycle is behind us measures of consumer credit quality not deteriorating, delinquency rates decreasing. All positive factors. Best case scenario: spending cuts not front-loaded and tax code changes more immediate. This is a “senseless, self-imposed crisis.” With progress toward mitigating deficit, economy accelerates because there is stimulative policy in place if we can overcome political dysfunction. On stimulative economic policy, he says revenue as share of GDP fell to 14%, stimulus prevented far worse outcome but is now running out. Deficit top layer of other issues: revenues must increase, entitlements should be pre-funded to avoid a crisis out in the future. Where is the safe harbor? Nowhere is 100% safe right now but treasuries are the safest assets out there still. Moving money to other countries’ bonds builds currency risk in. There is no riskless asset, but there is reason to believe this crisis will pass and be resolved.

There were two big takeaways from this call for me. One, there is no question that this economist, at least, views revenues as a key piece of the package. In fact, he was pretty clear that immediate cuts with out revenue increases were necessary not only to stabilize the markets and our credit rating, but to push the economy back into a growth phase. Two, the markets aren't freaking out because there's recognition that this is a "senseless, self-inflicted crisis" which could be resolved if Congress puts on their big boy pants and starts acting responsibly. If they do not do that, or if John Boehner continues to kowtow to the Tea Party (assuming the Senate can reach some sort of compromise internally), that self-inflicted wound could turn into a near-death blow.

Finally, one other theme emerged out of this call. When Ron Paul calls for the Treasury to forgive interest on internal debt and the very real possibility looms that interest rates could increase on Treasury bonds as a result of either a default or a failure to come to a reasonable agreement on deficit reduction, it is clear the target for both of these is Social Security, since the bulk of our internal debt is on Social Security trust funds. To be clear, if that interest were forgiven, $1.6 trillion -- TRILLION -- is immediately stripped from the trust fund. And if interest rates increase, the deficit will increase simply because interest will also be paid at a higher rate on those same trust funds, along with other debt, which will erode its solvency sooner than 2037.

Imagine Social Security, Medicare and Medicaid in a box. Surrounding the box are progressives, Democrats, and yes, even the President, locked in a protective stance. Surrounding those people are a bunch of wild-eyed lunatics with stones and weapons, looking for every possible way to break that lock and loot the box. That's where we are right now.