3 mins. to read

By Filipe R. Costa

These days, looming economic threats are just greeted with a collective shrug of the shoulders and a general feeling of “meh, seen it all before”. Heading towards October, now it’s the time for the Debt Ceiling Debacle to rear its ugly head yet again. For the third time in a row, the “debate” centres on Republicans attempting to extract concessions from Obama’s social programmes, while the Democrats respond with accusations of policy brinkmanship. It’s all very tedious and does nothing to solve what is obviously a crisis in the making.

The smart money is probably betting that this latest round of debt ceiling horse-trading will reach the same conclusion as the last two occasions. An agreement will be made at the very last minute, which will almost certainly involve simply extending the self-imposed limit on the Federal deficit and kicking that can down the road. (Just how much road can there be left?!)

At this point, we can all go back to sleep until the issue reignites as Federal borrowing nudges up to whatever the next threshold is.

What many people seem to forget is that there is a bigger problem behind the debt ceiling, which is the debt itself. When President Clinton left office in January 2001, the debt ceiling was $5.95trillion and the debt-to-GDP ratio was about 55%. During his presidency, Clinton’s administration had been able to reduce the debt-to-GDP ratio by 9%, from 64% in 1993.

Things were very different under President Bush. Over the following eight years, the debt ceiling was raised seven times, finally reaching $10.62trillion. When Bush’s presidency came to an end, the US debt-to-GDP ratio was 77%. After all, the money for those tax cuts and wars had to be found from somewhere!

This left poor old President Obama inheriting a right old mess. One would have thought he would have made it his number one priority to set about restoring America’s public finances, employing the same fiscal discipline that had been behind the success of his democratic predecessor. But no, within the first year of his second term the debt ceiling had to be raised for the fourth time during his period in office. Now America’s debt-to-GDP ratio is 102% and rising.

The Bipartisan Policy Centre recently estimated that the US Government will only be able to pay its bills until October 18th. By mid-October the Treasury will only have $50billion in cash, plus a trickle of revenue. If the situation is left unresolved, then there are only two possible outcomes. Either the US will be forced into making a selective default on certain debts or it will be forced to delay/restructure payment terms (which would be a default in all but name).

In the event of a selective default it is most likely that the US Government will do all in its power to keep bondholders placated. This means that any delays in payments would almost certainly be forced upon government spending programmes, which could include anything from the military to IRS refunds. Were this actually ever to happen, the chaos it would create in markets is almost unimaginable. And the trouble wouldn’t stop there. Severe social disorder would almost certainly follow.

However we probably aren’t at the point yet. Just in the nick of time Congress, the Senate and the President will suddenly find common ground, the debt ceiling will be raised, the Fed will continue to print money and the bills will keep being paid.

As long as the Fed is able to keep the printing presses running everything will be fine. At least it will be fine in the sense that the Fed could end up owning 100% of US Government debt, paid for by money it’s printed. I’ll be honest with you; this isn’t my idea of fine at all!

However, as much as it pains me to say it, for the time being it makes no sense to fight the tide. Although monetisation of deficit spending (i.e. printing money to pay bills) is folly of the highest order, while the market continues to believe in this confidence trick, things will carry on as they are. That is until they don’t…..

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