I haven’t posted much on the debt ceiling issue for two reasons: 1) It’s covered elsewhere ad nauseum, and 2) The odds of an actual default are remote.
But the bond market is pricing in a tangible default risk, and that can’t be casually dismissed. Today for instance prices of some Treasuries maturing in early June are low enough their indicated yields are in excess of 7%. That’s two full percentage points over Fed funds. Now to be sure the price changes on such short maturities to produce such yield changes are small, the affected maturity date range is small, and the overall yields in the sub-one-year Treasury space are still averaging under 6%, but still …
… seven percent TBills?
Did we just wake up in the nineties?
It’s hard to extract a coherent message from the financial markets. As you might expect, Treasury prices in general are being depressed, but it’s hard to suss out just how much from debt ceiling drama, how much from ongoing supply due to stultifying deficits, and how much from persistent inflation. Meanwhile stocks, while having a moved a bit lower, are far from exhibiting signs of real fear, and it’s far from assured that what’s in financial media headlines is what’s actually driving stock prices to begin with. Headline writers are drawn to drama, but the factors actually moving stock prices at any given time are multifold.
Reports indicate there is still a lot of daylight between the parties’ positions. Politics has been called the art of compromise, but negotiators on both sides are dealing with recalcitrant constituencies. They are keenly aware of the potentially catastrophic consequences of an actual default.
Neither side is going to get everything it wants, and neither side is blameless. Dominating both houses of Congress and the White House, Dems had two years to spend unopposed, and they milked it for all it’s worth. Now they have to share power again, and the cynically named “Inflation Reduction Act” isn’t going to be an indefinite free-for-all. Reps, for their part, were hardly models of fiscal probity when they were last in a similar position. This has not only added to debt, but compromises whatever moral gravitas they might otherwise have had now.
Realistically, it’s inevitable that the gap between revenue and spending will narrow. The only question is whether it’s voluntary or involuntary. The bond market is already showing signs of difficulty swallowing the massive supply of Treasury debt, and lower prices and higher yields will only add to the burden. While the supply of dollars is theoretically unlimited, the actual resources available to the US economy are finite, and consumption by the federal sector necessarily comes at the expense of the rest.
But going from a deficit denominated in the trillions to a balanced budget isn’t going to happen overnight. The debt will increase, and the ceiling will be raised, one way or another. Deficits will come down, one way or another. It’s just better that it happens in a deliberate, orderly way, before it happens another way.
While the overwhelming likelihood is that the debt ceiling is raised in time to forestall disaster, what if it isn’t? A variety of proposals have been floated as emergency measures. They’re all unattractive, but some less so than others. One involves taking some language in the fourteenth amendment out of context to bulldoze over Congress via executive fiat. This would be both politically and constitutionally catastrophic, possibly even worse economically than overt default. Less bad would be the the platinum coin proposal advocated by Paul Krugman.
In this proposal, the US Treasury mints a platinum coin with a face value of, say, a trillion dollars. Its metal content would presumably be, well, much less than a trillion dollars worth of platinum. The coin would be deposited with the Federal Reserve and used to write checks, all without incurring any debt. It’s not popular, and even TSec Yellen has panned the idea, but it’s IMO at least within Treasury’s constitutional prerogative. The main downside is that it would be greasing a slippery slope that potentially ends in hyperinflationary collapse. I didn’t say it was a good idea … just less bad than some others. Including default.
The near term course of investment assets is difficult to call. One might think that even if the safe haven aspect of treasuries were called into question, gold’s wouldn’t. Yet gold prices have lost some steam. Instead dollars themselves appear to be the main beneficiaries at the moment, being reflected in lower dollar prices for most everything else in today’s market action.
But is this because of the debt ceiling drama? Or is monetary policy beginning to regain some of the traction it had for most of last year? This is just what the Fed would want to see as an early indicator. We’ve speculated about the possibility as recently as yesterday. I’m leaning towards the view articulated early last year that at minimum, some extra cash wouldn’t be unreasonable.