How The Debt Ceiling Could Affect The Market
February 16, 2023 | Sage Capone
Key Points for Hawaii Investors
- We think it’s a very short-term phenomenon where the market ultimately rebounds
- Spending is already approved and now we go through this process for political posturing
When you issue debt it becomes somebody else’s asset and it’s two-sided accounting
Market Perspective
The media has been talking about a debt ceiling showdown and how it could affect the market and the economy. Congress needs to vote whether to raise the debt limit again which could have consequences on the United States economy, global stability, and everyone’s finances.
What is the Debt Ceiling?
The Debt ceiling relates to how much the Treasury can technically borrow to pay all the debts or what is already authorized by congress to pay. That would be Social Security, Medicare, Medicaid, government salary’s, interest on the debt, and so forth. But I think it is important to point out that this doesn’t raise spending. Spending is already approved. The next step is a secondary process where congress has to raise the authorized amount that the Treasury can go out to the market and issue Treasury Securities or Bonds to pay for those already authorized payments that the Government has already approved.
The last time congress had a close call with the debt limit was back in 2011 when the Federal Debt stood at 14 trillion dollars. Before defaulting, congress did reach a deal but not before the stock market dropped 14% over four weeks. This period was a very acute, short-term market action. For investors, a 14% correction in the market has happened on average once a year for the last 40 years. Now, not every year a 14% correction happens but on average it has happens once a year.
A market correction can happen for a variety of reasons and this debt ceiling showdown could be a reason that it does kind of go through those challenges as well. Still, I wouldn’t say it is a reason to time the market and sell because back in 2011 during that period the market bounced back just as fast and quickly and went on to continue rallying to 2012 and went on for a multiyear run from there. In our opinion, we think it’s a very short-term phenomenon where you could kind of have this knee jerk reaction but then the market ultimately rebounds.
During this showdown there is the possibility of a risk of default on risk free treasury debt and virtually all financial assets are priced in relation to treasuries. Do we see that scenario happening and where would investors go if treasuries were no longer risk free?
We don’t see it happening for a couple reasons. One, this kind of idea of a debt ceiling is very antiquated. The United States is a modern financial market and one of only 2 developed economies in the world that have a debt ceiling. That’s the United States and Denmark. The spending is already approved and now we just go through this process for a lot of political posturing as opposed to any economic benefits or any arguments related to the debt.
The other part of this is just because you have debt, remember it is two-sided accounting. On one side you have somebodies’ debt and another person’s asset. Right now, we have investors in treasuries that are expecting those interest payments and so forth and so on. It would be irresponsible to default on the debt. In addition, if it got to that point, you probably need a congressional or constitutional lawyers that would get involved because of the 14th Amendment. In the 14th Amendment it states that the United States Government Debt is unquestioned. In other words, telling you to pay the debt without question. So, we think it will be a very interesting showdown at that point but I think it would be really irresponsible and really not benefit anyone at that point. A default can push interest rates even higher drastically affecting the cost of borrowing.
Regarding the surging borrowing costs, that affects almost anyone as well. The treasury market is the deepest and most liquid market in the world and the United States, Global Investors and Pension Fund Investing and the regular public rely on it heavily. In the case that something like that were to occur and go down that path. We would go down a path where the United States dollar would start to be replaced in a sense that you would have this de-dollarization happening. Some of that is happening at this point already around the world as well. We would have a combination of currencies that replace the dollar. The treasury market is the deepest and most liquid market so large pools of capital have to go there and that’s one of the benefits of why the United States has attracted capital so long for years and that should continue.
If the government defaults on its debt, there could also be a lapse in the 90 billion dollar monthly social security payments made to 65 million people. We think it’s very important and this idea is also foolish. These are promises that have been made and again when you issue debt it becomes somebody else’s asset and it’s two-sided accounting. The idea that the United States government is like a family household budget I think misses the point. The Unites States Government is a currency issuer. Families with budgets are users so that’s a big difference. Again, trying to balance the budget or this idea is not the right motivation. It’s really balancing the economy that’s important.
How about the rumors of minting a trillion-dollar coin? This is very interesting, and it’s not as terrible of an idea. But really what they do is mint a trillion-dollar coin and then the treasury will deposit it at essentially the Fed which will then deliver to the Treasury to allow them to spend and use a platinum coin. Not a Gold Coin because the legislation says there is some limits what you can do with Gold Coins. But with platinum there isn’t that limit so you can go up to larger denominations. So that’s where you see that trillion-dollar platinum coin being printed.
Source:
Mark DiOrio and Brookstone Capital Management Investment Committee.
Source:
Federal Reserve
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