Are Conservatives Weaponizing The Dems’ Debt Ceiling Problem?

Jul 29, 2021

Are Conservatives Weaponizing The Dems’ Debt Ceiling Problem?

Republicans have the left pinned, and it could get ugly for us all...

This week we explore:

• The heated battle between Democrats and Republicans over the expiring debt ceiling.

• The consequences for Americans as a whole (and investors specifically) of either outcome of the battle.

• A third option that investors can use to profit from the entire sordid affair.

“Promises make debt, and debt makes promises.”

Dutch Proverb

Former Fed Chair Ben Bernake once said “The U.S. government has a technology, called a printing press, that allows it to produce as many U.S. dollars as it wishes at no cost.”

That printer may be running out of ink at long last as 2019’s debt ceiling agreement gets set to expire next week. The Bipartisan Budget Act of 2019 suspended the debt limit, allowing for the government to borrow as much as it wanted.

Should the debt ceiling not be raised, and no agreement reached, whatever the federal debt is on that date becomes the new debt limit, with no additional borrowing allowed.

That number currently stands at $28.5 trillion.

According to the Congressional Budget Office (CBO), debt would exceed 200% of GDP by 2051. Today this number currently stands at the highest in history at 129%, 5% higher than during World War II.

We are currently adding $120 billion per month to the balance sheet through bond purchases. This is a pace of nearly $1.5 trillion dollars per year. And even though these bonds sit as Assets on the Fed’s ledger, we also need to print the money to buy those bonds.

This is a problem we created ourselves during World War I. Before then, Congress had to authorize each individual bond offering by the U.S. Treasury, including interest rates and maturities.

But federal borrowing was so massive during the war that it was impossible for the Treasury to secure funds in a timely manner, leading Congress to give the Treasury general borrowing authority subject to a limit. This limit became known as the debt ceiling, and it continues to be used as a weapon today.

Democrats missed an opportunity to include a debt ceiling increase in President Biden’s $1.9 trillion coronavirus relief package, passed in March. Which means the Republicans will horse trade to provide consent.

Every few years, the debt ceiling issue rears its head as the minority party uses it as a negotiating tool against the party in power.

A full default by the U.S. government has never occurred, but as any successful investor can tell you, past performance is not indicative of future success.

Just because it’s never happened before doesn’t mean it couldn’t happen now.

Today, that means Republicans have an opportunity to throw a monkey wrench into the current Blue Wave -- and they seem intent on using it to gain back some control over Biden’s spending spree.

But will it be enough to overcome the Dems’ majority?

The Big Picture

If lawmakers can’t reach another agreement before the end of the month, the debt ceiling would automatically be reinstated at the current level of debt, and the Treasury wouldn’t be able to sell bonds or government securities to raise funds. This would essentially mean the government would ultimately be forced to default on its debt.

What does that mean, exactly?

We need only go back to 2011 for our evidence. The 2011 debt crisis sparked the most volatile week in financial markets since the Housing Bubble collapsed in 2008, driving stocks significantly lower and pushing gold prices to historic highs of over $1900 per ounce.

Should a crisis happen again today, to Americans, the default would likely hit public programs, Social Security beneficiaries, and veteran benefits first hardest.

To investors, the Treasury would no longer be able to pay interest to bondholders or redeem bonds that have matured.

In June, Treasury Secretary Janet Yellen already touched on the issue, noting that government spending uncertainty could mean the Treasury runs out of money as soon as August.

And if the Treasury can’t raise new cash, it would take what’s known as “extraordinary measures” to keep paying the government’s bills in full and on time.

These measures, which have been used in the past, include cashing in investments in federal pension programs and suspending new investments in those programs. But while that’s bought time in the past, Treasury officials have said the same measures today would be exhausted significantly more quickly than in the past.

There are those who have suggested that the government should default and not lift the debt ceiling.

This includes Mick Mulvaney, Donald Trump’s Head of Office of Management and Budget appointee, and even President Trump himself, who in 2016 hinted that defaulting on the national debt could be used as a negotiation strategy to reduce debt.

But as Ronald Reagan said in 1983, “The full consequences of a default—or even the serious prospect of default—by the United States are impossible to predict and awesome to contemplate. Denigration of the full faith and credit of the United States would have substantial effects on the domestic financial markets and on the value of the dollar in exchange markets. The Nation can ill afford to allow such a result.”

Conservatives refuse to yield and Democrats refuse to negotiate. But as both sides butt heads, Biden and the left continue to propose trillions in new debt to be added to the tab.

According to the New York Times today, the Biden administration has added bribery to the list of proposed expenses, and has floated the idea that states and cities should pay people $100 to get vaccinated.

The blowout on deficit spending has no end in sight. The Democrats have already proposed a $3.5 trillion budget package to expand Medicare benefits, boost federal safety net programs and combat climate change; some of Biden’s top economic priorities -- all in addition to Biden’s $1 trillion infrastructure package.

That’s $4.5 trillion in new debt, which ordinarily would never pass muster, but as we’ve stated many times in the past, what’s crazy in normal times becomes necessary during a crisis. But these plans could essentially be nullified without agreeing to terms on a new debt ceiling.

It’s why the leverage could be too juicy for Republicans to roll over on.

However, the Dems have a third reconciliation bill in their back pocket which they’ve been saving for exactly such a bill.

Reconciliation bills are measures which can pass with just 51 votes instead of 60. These bills are tied to fiscal policies, with recent examples including Obamacare, Trump’s tax plan, and the $1.9 trillion American Rescue Plan stimulus package.

Democrats already had the ability to pass two budget Reconciliation bills this year, one focused on fiscal year 2021 and one focused on fiscal year 2022. But a recent decision from parliamentarian Elizabeth MacDonough, based on an interpretation of Section 304 of the Congressional Budget Act of 1974, gives them a third, allowing lawmakers to revise a budget resolution before the end of the fiscal year that it covers.

This means that so long as the bill is related to taxing and spending, Democrats can now edit any 2021 budget resolution they already passed, and include instructions for another bill -- including a $3.5 trillion Medicaid bill. What remains an open question is could the Dems sneak in the debt limit on a reconciliation bill?

So what happens if there is no new agreement on a debt ceiling?

With no ability to borrow, the government would not simply stop passing bills. They’d use “extreme measures” to cut money from elsewhere. As mentioned above, that includes social security, veterans benefits, public works -- and treasury bonds.

Hypothetically speaking, if the government were to default on bonds, there would be no baseline (or security) for these debt instruments, and we could see borrowing costs explode for Americans, even with the Fed pinning interest rates at near historic lows. After all, it’s impossible for the Federal Reserve to implement Yield Curve Control on the long end when one no longer exists.

Rising rates, of course, would collapse the heavily inflated markets and the whole Ponzi scheme could come crashing down.

According to the CBO, the Treasury’s cash balance is projected to be $450 billion at the end of July with federal revenues totaling $786 billion from July through September, while spending will reach $1.551 trillion.

That leaves a $190 billion deficit over the course of 3 months.

The CBO has already acknowledged the difficulty of making precise forecasts on how long the Treasury will be able to get by without new borrowing, and what that borrowing looks like is anyone’s guess.

The best estimate of a "drop-dead date," on the debt ceiling comes from the Bipartisan Policy Center, which believes early November, but no one wants this saga to drag on that long.

All of this does present another interesting thought, though…

Should no agreement be reached, financial markets are likely to erupt into chaos.

The volatility and confusion could cause tightening on cash flow into markets and paper assets, and the country would likely fall into another recession.

Of course, because we’ve all seen this game of political chicken before, we all believe they’ll get a last-minute deal done. No politician wants the blame for having shut down the government.

As far as the national debt and its borrowing ceiling today are concerned, we believe an agreement will be reached in the 11th hour, but not before Republicans get concessions.

It probably means the Dems will need to commit to some tighter fiscal spending, and could potentially come with restrictions on how they’ll be able to use their reconciliation bill.

That said, it’s pretty tempting for Republicans to make a stand here, and why we will likely see more stressful days ahead, especially with the Democrats already creating the next crisis by suggesting the moratorium on evictions, which expires at the end of the month, should be extended because of the Delta variant.

Our best guess is that Congress will kick the can for a couple of months before actually being forced to do a bigger debt ceiling raise by the end of the year.

Not to worry. The debt ceiling will definitely be lifted.

The reason why is simple. More and more debt is the only thing the left and the right can both agree on these days.

Best,

Adam Baratta

CEO

Brentwood Research