The Next Debt Ceiling Crisis

Posted by Jacob Radke

In the early 1970s, the US defaulted. Back then paper money was like checks in a checkbook, paper dollars had no real value except for the fact that they could be exchanged for gold.

The US started running larger and larger deficits, meaning they spent more than they earned, and had to print more paper money (but had the same amount of gold).

When people started exchanging that paper money in for gold it became clear that the US wouldn’t be able to keep its promise to exchange paper dollars for gold and defaulted on those paper notes (otherwise known as debt).

Now we are seeing that the debt ceiling is in the news again. Yet I still don’t believe we have anything to materially worry about.

If the debt ceiling isn’t raised that would be bad. It would mean that the US would once again default on its debt.

But what do you fall back on if the debt ceiling isn’t raised and we do default?

Nixon was able to state that “the strength of a nation’s currency should be determined by the strength of that nation’s economy, and the US economy is by far the strongest.”

A default on U.S. Treasuries could lead to a violent reversal of the trend where people see Treasuries as a safe-haven asset because investors lose faith in future payments on U.S. debt. 

This could have far-reaching negative impacts on a wide range of financial assets including U.S. bonds, equities, and the dollar (and the possibility of a global reserve coo). 

Relative winners of a US default could include real assets such as gold, high-quality international equities, and the government bonds of countries not in default crisis.

The reason I really don’t see this being an issue is that this would be a political nightmare for any politician to not pass. It would completely ruin their career.

In every election they ran in that would be poison to their campaign, because it would damage investor faith in the US markets.

Liz Truss's Debt Crisis

Take Liz Truss for example. A little bit of a different story but she announce fiscal easing, meaning she announced large tax cuts in the name of inflation relief.

When she did that three things happened.

  1. The Central Bank of England was raising rates, effectively increasing the interest payments by the UK government.
  2. The Fiscal government said that they were going to make less money in the wake of higher inflation. More payments + less income = bad outcomes.
  3. Investors lost faith that the UK would be able to keep its promise and pay them back, essentially seeing a historic bond market selloff.

Then she resigned within seven weeks of being inaugurated.

Investors losing faith in their nation’s debt is a bad thing.

The 2011 Debt Ceiling Crisis

Where we stand today may not be all that different than 2011.

The 2011 United States debt-ceiling crisis was a part of the political debate in Congress on what the appropriate level of government spending is and what its effects on the national debt and deficit are.

The debate was centered on the raising of the debt ceiling.

The Republican Party, which gained control of the House of Representatives in January, demanded that President Obama negotiate over deficit reduction in exchange for an increase in the debt ceiling.

On July 31, two days prior to when the Treasury estimated the ceiling would be hit, Republicans agreed to raise the debt ceiling in exchange for a complex deal of significant future spending cuts.

The crisis sparked the most volatile week for financial markets since the 2008 crisis.

2023's Potential Debt Ceiling Crisis

The new Speaker of the House, Kevin McCarthy, has said that any debt limit increase should be accompanied by spending cuts. And that echoes the demands of some of the Republican members who finally elected him speaker earlier this month.

That's not all that different than 2011 and it was Mark Twain that said, "history never repeats itself, but it does often rhyme."

A divided congress, a debt limit that needs to get raised, and a tightening Fed could call for some short-term volatility.

But the debt ceiling in 2011 was eventually raised and the markets still closed the gap and gave a positive calendar year return.

That debt ceiling was raised because at the end of the day, defaulting on debt is not worth budget cuts even though budget cuts are maybe necessary to not have this problem again.

All in all more than likely you have nothing to worry about, and I hope this post ages well.

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