Manole Capital Management
Debt Ceiling
May 2023
Debt Ceiling:
As we are writing this newsletter, the market is “stressed out” about the pending debt ceiling dispute. Technically, the US government hit its allowed debt ceiling on January 18th, 2023, but Treasury Secretary Janet Yellen has been taking extraordinary measures to avoid the issue.
Why the moving target date? Well, the Treasury has eclipsed its $31 trillion debt cap, but one needs to factor in how much cash came in from tax revenues. The non-partisan CBO (Congressional Budget Office) has stated that “tax receipts through April have been less than anticipated” and “that there is a significantly greater risk that the Treasury will run out of funds in early June.” The not exactly drop-dead date is now June 1st.
Much has been written about what would potentially happen if the debt ceiling isn’t raised and whether or not it would trigger a global financial crisis. Here’s hoping we don’t get there, but let’s dive a little deeper into the details.
Since the debt ceiling was enacted by Congress in 1917, the US government has been close to a breach 78 times and it was resolved and extended 78 times. That’s a pretty good percentage, right? This Washington DC predicament has historically been little more than a technicality, but it occasionally becomes an issue – like it did in 2011. Back then, the US government was close to reaching its borrowing limit of $14.3 trillion (now +120% higher) and the stress ultimately caused a credit rating downgrade. Why would this time be different?
We found a quote from October of 1984, from then Senator Joe Biden, that seemed apropos for today’s debt ceiling concern. Senator Biden said, “I cannot agree to vote for a full increase in the debt ceiling without any assurance that steps will be taken early next year to reduce the alarming increase in the deficits and the debt.” During that 1984 debt limit debate, Senator Biden joined forces with Senator Tsongas (Democrat from Massachusetts) and asked for a smaller debt limit increase than the White House was asking for, as well as a vote to freeze all federal spending.
Sound familiar? Sounds exactly like a quote we’d expect from House Speaker Kevin McCarthy. This statutory debt ceiling issue is yet another bitter partisan battle that causes more Americans to distrust politicians and Washington DC.
There are really only four choices and a couple of them would be unpleasant. The first is a clean increase in the debt limit, with no conditions. During the Trump administration, this occurred three times and dozens of times during previous presidencies. While one can hope for this option, it seems to be fading each and every day. The second option is a negotiated debt ceiling raise, that solves this current impasse and gives politicians an opportunity to reach a more substantial deal later this year. House Republicans claim that this is their preferred outcome and passed their own bill last month. That bill calls for limits on federal spending, adds $1.5 trillion to the debt ceiling and essentially is a short-term punt on the concern.
The third option is executive action that would bypass the debt limit. This would be unprecedented and might have President Biden declaring the debt limit unconstitutional, arguing it violates the 14th Amendment’s clause that says, “the validity of the public debt of the US…shall not be questioned.” Another bizarre scenario has the Treasury minting a $1 trillion platinum coin to deposit at the Federal Reserve and infuse the government with enough money to pay its bills. We don’t believe this will ultimately get settled with a legal fight or the creation of a $1 trillion trick coin.
The last option, which is even worse than the third, is a government default. Moody’s Analytics chief economist is Mark Zandi, and he described a government default as “financial Armageddon.” Treasury Secretary Yellen emphasized that the US failing to raise the debt ceiling would be “an economic and financial catastrophe.” What happens to the US dollar? What becomes of the world’s RFA (risk free asset) if US debt isn’t the safest of safe investments?
Conclusion:
This debt ceiling issue is coming at an awful time for the market. Investors are still trying to figure out how this business cycle will evolve, following persistent inflation and a once-in-a-generation global pandemic. Adding uncertainty about the US government’s ability to pay its bills isn’t what the market wants to deal with right now. We anticipate (and hope) that policymakers will reach a solution that “kicks the can” down the proverbial road.
We’re a fundamental research shop, exclusively focused on the emerging FINTECH industry. As DC figures out its latest manufactured issue, we’ll be updating our proprietary models and reading Q’s and transcripts. We did notice that CME’s interest rate complex just hit its all-time high in open interest (leading indicator of future volumes) for the 5th straight day.
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