Cartoons of the Week:
Oh, the Drama We Make Up….
Here we go again with another episode of the DEBT CEILING. The biggest made-up drama our country can provide.
I hate this subject. I hate the pointless drama of the entire thing. Especially when it comes from Congress. But this will be the subject we will all be hearing about as the year progresses, so I wanted to give you a quick down-and-dirty on what it is and what to expect.
What is the Debt Ceiling?
With an amendment in 1917 and updated in the 1930s, Congress was given the right to specify a debt limit on all federal debt.
Congress also has the power to tax and spend money. Congress controls taxes AND how much we spend.
When you spend more than you make, you create a deficit.
What is a Deficit and why do we Have a Vote on a Debt Ceiling?
A deficit is a difference between how much we make as a country and how much we spend.
A deficit is a shortfall between income and expenses. You as a consumer fund shortfalls with credit card debt, housing debt on second mortgages, or some other form of debt or borrowings. The country is no different.
As a result of a deficit, Congress has to VOTE on a debt ceiling, authorizing the government to borrow money to fund the deficit Congress also approved.
This is what makes this a uniquely American problem. The great American drama.
No other developed country besides Denmark has a debt ceiling. And for Denmark, their current ceiling is almost double their outstanding debt today.
We, on the other hand, go through this ordeal a few times every 4-5 years. An ordeal that puts the country on notice, puts our credit rating at risk, and ultimately may one day have a huge impact on your daily life.
How does this All Work? A Quick 101 of Bill Paying
To understand how we pay bills, you have to understand a few things first.
The Department of Treasury was established by Congress in 1789, 13 years after the Declaration of Independence.
The Treasury's main goal is to manage the government finances. They collect taxes, make coins and currency, enforce finance laws, and supervise financial institutions.
One other major thing they do. They issue our debt to fund our deficits.
Notice they DO NOT set spending and tax policy. That is Congress, which we discussed above.
All Treasury does is take the instructions Congress gives them and executes the plan.
Treasury is the cog that makes it all work.
When we need to pay for a deficit (our extra spending over what we have brought in through taxes), the Treasury will issue notes, bonds, or bills.
These new treasury securities “called Treasuries” are secured by the full faith and confidence of the United States and purchased by U.S. banks, international governments, international banks, and foreign citizens.
Treasuries are the most held securities in the world. Most foreign reserves are held in treasuries.
Below is the current list of countries holding US Treasuries.
Where does the Federal Reserve Fit into This?
In past writings, I have talked in detail about the Federal Reserve. Where do they fit in?
The Federal Reserve is the central bank of the United States. The Fed oversees the currency, the monetary system, and all banking activities. Since 1951, the Federal Reserve sets the rate that is charged on our debt without any Treasury interference.
When the Federal Reserve wants to inject liquidity into the market or to lower interest rates, they will go to banks and BUY Treasuries from those banks and give the banks hard currency or money.
Important to remember - The Federal Reserve is not allowed to buy Treasuries directly from Treasury. They have to buy Treasuries in the open market from banks, institutions, and individuals.
Why is the Debt Ceiling Such a Big Deal?
The current debt ceiling is $31.4 trillion, which we officially reached last week.
Since 1960, the limit has been lifted 78 times – 49 times by Republican presidents and 29 times by Democratic Presidents. Historically, it was never a big deal. It usually was raised as the last step in finalizing the federal budget and spending processes.
The passage of the debt ceiling in 2023 will require all Democrats and four Republicans in the house and 60 Senators in the Senate.
This time around, Republicans have put a line in the sand. The White House has also put a line in the sand.
Unfortunately, these lines are very far apart.
The White House has stated a “no negotiation” stance on the debt ceiling.
Speaker McCarthy and the Republicans will tie any debt limit votes to a budget resolution to balance the budget over the next 10 years (that is a cut of $2.4 trillion or equal to all social security payments).
Specifically, they want to see around 20% in spending cuts from non-defense spending along with increased measures of border security.
Good luck getting that by a Democratic Senate and President.
If we already have Reached the Ceilings, why is it not a bigger deal?
Treasury still has plenty of cash on hand to fund the government without issuing new debt.
The Treasury currently has $455 billion in its checking account that it can use to run the government. If this runs out, it has a few different means known as extraordinary measures to provide funding.
But eventually, the cash and extra measures will run out. When this happens, X date will hit!!!
(Script: play scary music here)
What happens on X Date?
X Date is the potential default date on our debt or other extraordinary spending cuts.
Early June is the time frame we may reach technical default. By late July or early August, if congress has not voted on raising the debt ceiling, all cash will be gone from the treasury.
A technical default would involve the Treasury Department picking and choosing which bills to pay.
Comments by the FOMC in 2013 about X date:
“Principal payments on maturing Treasury securities would be funded by Treasury auctions that roll over the maturing securities into new issues, so the new issues would fund the redemption of the maturing securities. Interest would be paid based on available cash in the Treasury general account. To make a coupon payment, however, the Treasury may need to delay or hold back making other government payments, even if it had sufficient balances on a given day, in order to accumulate sufficient funds to pay a future large coupon payment. Prioritize payments means we pay interest instead of social security, Medicare, or paying our government employees or our troops overseas.”
To stop a news cycle landmine before it begins, House Republicans are considering an approach that would include principal and interest, Social Security, Medicare, veterans’ benefits, and defense funding, per the Washington Post.
If this is true, it means they are in for the long haul and going to fight till the end, which is bad news for the markets, and potentially bond prices and inflation.
What would these Prioritized Payment Cuts Look Like?
Per Andy Laperriere at Piper Sandler:
“On an annualized basis, the cuts would be enormous – at around 10% of GDP in the GOP priority scenario and closer to 20% or 25% of GDP in the interest-only scenario.”
To give you an idea of how bad Andy’s estimates are, look at the annualized percentage change in GDP since 1930. We have not seen any annualized rates of GDP lower than 10% since World War 2.
Now before you go start to build a shelter, buy guns, and hoard food that will last for 200 years, note that this analysis is probably not realistic, as any technical default will be extremely short.
As Andy continued:
“If the X-date was binding in early June and the impasse went on for ten days, the US could default on between $160 and $300 billion in obligations (though they’d of course be paid back after the impasse was over). Our estimate is the X-date is likely to fall in August. If a technical default is that short-lived, the political fallout is probably greater than the economic fallout.”
What can Fed or Treasury do to Prevent a Default?
There are a few tricks up their leave if Congress decides to risk our countries debt rating for their agenda:
Treasury can issue the famous $1 trillion Platinum coin. By a weird loophole in the law, the Treasury can print a platinum coin with unlimited value. Please note - It has to be platinum. Theoretically, they could print a $1 trillion platinum coin, walk over to the Federal Reserve and deposit it, and receive $1 trillion in funds from the Fed. I wrote about this in the past and may post that write-up again in the near future on Substack.
The Fed could stop their Quantitative Tightening and even start Quantitative Easing again. This would support the Treasury market, similar to what the Bank of England did in late 2022 (wrote about it HERE). By implementing QE again, the Fed could support Treasury Prices and be the ultimate last resort buyer if needed.
The Fed could use or increase its Reverse Repo facility. If there was too much demand for Treasuries and the Treasury was no longer issuing bonds, the Fed could provide buyers like money markets and foreign governments with Treasuries by lending out securities at a certain rate they choose and buying them back at a later date. Basically, they could create fantom Treasuries backed by the Full Faith of the Federal Reserve, which is the US Government, which is the Treasury.
The Fed could just buy any securities in technical default. As Jay Powell stated in 2013 about this option:
“I don’t want to say today what I would and wouldn’t do, if we have to actually deal with a catastrophe on this.”
What can the President do to Prevent a Default?
Invoke the 14th amendment.
As stated by JP Morgan Chase:
“The Public Debt Clause of the 14th amendment to the Constitution states that “The validity of the public debt of the United States… shall not be questioned.” One possible interpretation of this clause is that Treasury simply must continue paying its debt – failure to do so would be unconstitutional. Legal scholars are divided on this interpretation, in part because the Supreme Court has rarely offered an opinion on this clause. So far, Treasury Secretary Yellen has insisted there is no plan to invoke the 14th amendment.”
The Bigger Picture
This entire process is a joke.
Congress is constantly playing chicken with our national security. We risk another debt downgrade by their actions. We risk another hit to public opinion about our government. We risk giving our advisories another reason to push for reforms in world trade and to push for other alternatives.
And for what? A promise to cut spending, which we all know will never happen!!!
Right now foreign buyers hold over $7 trillion in US debt.
Foreign demand for US Treasuries hit record levels this past week.
As stated by Bloomberg:
“Indirect bidders (foreign buyers) accounted for 75.7% of Wednesday’s $43 billion sale of 5-year notes — a record share. They snapped up 77.1% of Thursday’s seven-year auction versus a six-month average of 67%.”
Why put any questions into buyers’ heads if our government will fund these coupons?
If foreign buyers stop buying, the exchange value of the dollar will decrease, putting more pressure on prices and increasing inflation.
The worst case is the stability and function of our financial markets would seize up, as people question the safety and stability of our treasury market. This would put a halt to our economy overnight and create a potential debt crisis similar to or worse than 2008.
We need to address our spending and use of debt in our country. Ray Dalio has written an entire book on past civilizations that all collapsed because of excess debt use.
As he mentioned this week in a post on LinkedIn:
“Because money and debt are not limited, those who make the decisions on how much to spend on what don’t look at how much money they have to spend and then prioritize what they should spend it on. They instead decide how much they want to spend and then decide whether they will get it from taxes (which is hard because people fight to keep their money) or borrow it, and if they borrow it, they have to decide whether they sell it to lender-creditors who want it or sell it to central banks who print the money to buy it.”
We are a house of cards built on debt.
That does not mean Congress should use the debt ceiling as the opportunity to pull back the curtain and show the entire world what it looks like.
Have a Wonderful Weekend….