Janet Yellen: The Boy Who Cried Wolf?

Sep 20, 2021

Janet Yellen: The Boy Who Cried Wolf?

The Treasury Secretary Begs Congress to act, but who is listening?

This week we explore:

• How Janet Yellen’s WSJ op-ed plea to Congress reveals a dangerous game of chicken that ultimately has no winner

• The 3 harsh realities Yellen unwittingly reveals in her writing, and why they’re so significant to our country’s standing on the global stage

• What happens when the wolf finally shows up at the door?

“The wolf is always at the door.”

— Don Henley, “New York Minute”

Yesterday afternoon Treasury Secretary Janet Yellen, in an Op-Ed featured in the Wall Street Journal, literally begged Congress to raise the country's debt limit. Yellen's plea came with a warning that failure to do so would cause the United States to plunge into a financial crisis.

Our former Fed chair’s exact words were that should Congress fail to act now, it “would likely precipitate a historic financial crisis that would compound the damage of the continuing health emergency” and would “throw the U.S. into recession and leave it a permanently weaker nation.”

Yellen went on to argue that the United States has raised the debt ceiling 80 times and has never defaulted. She argued a default would trigger a “widespread economic catastrophe,” that in a matter of days would leave millions of Americans “strapped for cash.” She explained that “nearly 50 million senior citizens would stop receiving social security checks for a time, troops would go unpaid..and millions of families relying on child tax credits would see delay,” because, “America, in short would default on its obligations.”

What we find interesting about the letter was not the fear mongering tone clearly meant to alarm Congress and any voters following the story, but rather three other important realities;

The first, is the way in which Yellen highlights the exorbitant privilege that the United States holds controlling the world’s reserve currency. Yellen states, “For about a century, America’s creditworthiness has been a major advantage over our economic competitors. We borrow more cheaply than almost any other country, and defaulting would jeopardize this enviable fiscal position.”

Yellen is recognizing the reality that it’s the power of the dollar as the trading currency of the world. It’s this power alone that allows for never ending debts to be accrued by America, and why the United States controls 25% of the world's wealth while only contributing 5% to world GDP.

The second thing of note was how Yellen dismissed the relevance of the debt ceiling altogether. She said, “when we raise the debt ceiling, we are effectively agreeing to raise the country's credit card balance.” She argued this is not a problem the current administration created by spending, but rather one where “97% of that balance was incurred by past congresses and presidential administrations.” She went on to add, “Paying America’s bills should not be a controversial issue,” and why she is “confident our lawmakers will address the debt ceiling once again.”

As Yellen points out, we are applying for new credit cards when we have been unable to pay the minimum balance on the other 80 existing credit cards we have been late on for decades. Rather than suggest our runaway expense accounts need to be reigned in, Yellen argues the opposite. Pay particular attention to the hubris the former Head Custodian of the dollar possesses.

There is an assumption that we can continue our debt binge with no consequence, and that the only people that can screw it up are Congress not approving more debt. This is a disastrous long term strategy for the United States government.

The last time the United States ran a surplus was 21 years ago. Any new debt will surely be added to the existing pile that has been accumulating over the last two decades. There is zero chance that the United States will be in surplus anytime soon, and that our national debt will soon hit $30 trillion.

The third is a slight warning for anyone lulled to sleep by the Fed liquidity. It is how Yellen closed the note. While she couldn’t give an exact date for when the U.S would plunge into default, (she has formerly estimated that it would be sometime in October), Yellen reminded us that the last time that we even came close to not raising the debt limit in 2011 when the country was pushed to the edge of crisis, America's credit rating was downgraded, and there was a severe market downturn. “This led to financial-market disruptions and persisted for months.” Time, according to the Treasury Secretary, “is money here, potentially billions of dollars.”

But the debt limit has been the literal boy who cried wolf.

Everyone has heard this story before. And nobody can imagine Congress not extending or raising the debt limit. We all know that there will be grandstanding, wrangling, and threats. The Democrats will scream that the underprivileged will be irreparably harmed, while the Republicans will get on their soapbox and argue that reckless spending is creating inflation and destroying the integrity of our country.

For traders, the bad news will likely be interpreted as good news because it means the Fed, who meets this week to announce their policy stance, will be forced to keep their ridiculously loose policies going.

The Fed has been using Covid-19 as their full excuse thus far. We can now add the collapse of Evergrande in China as an additional reason to continue their weakening program.

The debt limit situation is just the icing on the cake and why we think it will be incredibly difficult for the Fed to suggest any real form of tightening this week. It seems ever more likely, especially given the tone of Yellen’s comments, the concern over systemic risk, and the Federal Reserve’s previous promises to let inflation run hot, that J. Powell will be forced on his hands.

The markets opened Monday down big. The Dow Jones dropped over 600 points, the S&P down over 1.5%. The dollar, ironically, got stronger, and 10 Yr yields continued to swoon lower.

Bitcoin, helping to make the case that it’s not ready for primetime, got hammered and was down nearly 10% to below $44,000.

The experiment of using Bitcoin as a currency in El Salvador has started as a disaster. Today's drop means the people of El Salvador have lost 15% of their buying power in the last few weeks since the country has made Bitcoin their reserve currency. How’s that for runaway inflation?

As for the U.S. debt limit.. in the end, as we all believe and assuredly will come at the last minute, Congress will do the one thing they can all agree on, which is to say “yes” to more unpayable debt.

The big question for the short term is how quickly will Congress actually act? There is little chance this happens soon without some disastrous market downturn. Eventually, it will encourage even more people to believe that debt doesn’t matter and our country will be even one step closer to the inevitability of modern monetary theory.

Until then, there will be many who argue we should do away with the debt limit altogether. Yellen herself has argued as much in the past. She has suggested that America cannot default on our debt because we can always print more money to pay our bills. That’s what we have been doing for the last decade. That is what is going to continue, at least so long as Congress doesn’t get in the way.

But, if the debt ceiling is actually the boy who cried wolf, we may all do well to remember the moral of that story.

Eventually, the wolf actually arrives and there’s nobody left to believe the boy.

What if Yellen’s pleas fall on deaf ears in Congress? How quickly would our Fed-induced bubble collapse? And, more importantly, how much money would the Fed need to create to reflate that epic decline?

We all know our current approach ends badly.. The only real question is will that end come gradually or suddenly?

Which leaves us to wonder if we really wouldn’t be better off defaulting on the debt at the current levels, while our debt to GDP ratio is 130% and 900% of our annual revenue.

Perhaps we should rip the band-aid off at once, rather than continue to prolong the agony of the coming reality. One where when interest rates truly become uncontrollable for the Fed, rise significantly, and there is nobody left willing to buy our worthless paper.

In the short term we will all get to witness the ironic reality of The Great Devaluation. If Yellen is right, Congress waits too long and we do see a similar fate to 2011, the Dollar, which will be in jeopardy of default, will likely scream higher as overvalued assets are sold and people rush into cash.

While the fear has been removed from the equation for Americans after so many previous debt-limit shenanigans, the fact that we are forced to consider the possibilities and the one question losing reserve currency status is one we would do well to appreciate.

What happens when the wolf actually arrives? Because, as Don Henley so famously wrote, “the wolf is always at the door.”

Of course, nobody is alarmed and that’s the most alarming part.

Best,

Adam Baratta

Editor in Chief

Brentwood Research