Debt Ceiling Armageddon

Get ready for screaming headlines...

The BUDGET DEFICIT will be hotly debated from March to next September, writes Jim Rickards at The Daily Reckoning.

It may result in a government shutdown at midnight on Sept. 30, 2023, if progressive Democrats in the Senate and conservative Republicans in the House can't agree on a budget for fiscal year 2024, which begins Oct. 1, 2023.

But there's another train wreck coming even sooner.

This one involves the debt ceiling and the infamous "X-Date" when the US could default on the national debt.

What exactly is the "debt ceiling"?

It's a numeric limit on the total debt that the US Treasury is allowed to issue. To be clear, the debt ceiling does not mean the Treasury cannot issue any new debt. It means that the Treasury cannot issue debt that increases the total outstanding above the ceiling.

With over $31 trillion of debt outstanding in maturities from four weeks to 30 years, there's always some existing debt that's maturing. The Treasury can issue new debt to pay off the old debt. It just can't increase the total.

So if $20 billion of debt matures this week, the Treasury can issue $20 billion of new debt to keep the total constant. They just can't issue $30 billion without breaking the ceiling. Treasury is at the ceiling now. The US is still running deficits. How are the new deficits being financed if Treasury can only conduct the "rollover" operations described above?

The Treasury has to resort to "extraordinary measures" to keep paying the bills. You may have heard of the "trillion-Dollar coin" idea. It won't happen, but here's how it works.

The Treasury would ask the US Mint to produce a solid platinum coin. The Treasury would give the coin to the Federal Reserve and simply declare that the coin was worth $1 trillion. (Assuming a one-ounce coin, the actual market price is about $1000.)

The Fed would put the coin in a vault and credit the US Treasury general account with $1 trillion. The Treasury could spend that newly printed money as it wished. The Treasury would not violate the debt ceiling because no new debt would be issued; the Fed would just create the Dollars out of thin air. Easy-breezy.

Of course, the trillion-Dollar coin policy would be disastrous. The arbitrary valuation of the coin would show the true Ponzi nature of the Treasury market today. Fed efforts to supply the cash would radically increase the money supply and probably trigger more inflation. The Fed and Treasury would be laughingstocks.

That's dangerous for two institutions that rely on public confidence to go about their business. Only the simpletons in financial media believe this idea is worth discussing, but it's good to understand it because you will be hearing more about it.

How long can this shell game go on? No one knows exactly. There are estimates that are referred to as the "X-Date". That's the day the Treasury really does run out of cash and can't pay bills or pay off Treasury note holders. Right now the X-Date is estimated to be around June 5, 2023, but even that is a guess.

The real X-Date will depend on how much positive cash flow the Treasury generates during tax season around mid-April. As the day approaches, Democrats will try to scare voters with claims of debt default, lost Social Security payments and lost benefits such as pre-K.

On the other side of the aisle, Republicans will scare voters with claims of runaway deficits, higher interest rates, lost confidence in the Dollar and money printing as far as the eye can see.

We'll have better estimates of the X-Date by April, and a kind of "countdown to default" will begin.

In the meantime, get ready for more volatility in stocks, along with higher interest rates. But let's look at the larger picture.

Those who focus on the US national debt (and I'm one of them) keep wondering how long this debt levitation act can go on.

The US debt-to-GDP ratio is at the highest level in history (about 125%), with the exception of the immediate aftermath of the Second World War. At least in 1945, the US had won the war and our economy dominated world output and production. Today, we have the debt without the global dominance.

The US has always been willing to increase debt to fight and win a war, but the debt was promptly scaled down and contained once the war was over. Today, there is no war comparable to the great wars of American history (though there are many who'd like to drag us into one in Ukraine), and yet the debt keeps growing.

We're accumulating debt at a substantially greater rate than we're growing the economy. Basically, the United States is going broke.

I don't say that to be hyperbolic. I'm not looking to scare people. It's just an honest assessment, based on the numbers.

Right now, the United States is roughly $31.5 trillion in debt. Now, a $31.6 trillion debt would be fine if we had a $50 trillion economy. The debt-to-GDP ratio in that example would be manageable.

But we don't have a $50 trillion economy. We have about a $25 trillion economy, which means our debt is bigger than our economy.

We are deep into the red zone, in other words. And we're only going deeper. The US has a 125% debt-to-GDP ratio, trillion-Dollar deficits and more spending on the way.

Monetary policy won't get us out because the velocity of money, the rate at which money changes hands, is dropping. Printing more money alone will not change that.

Fiscal policy won't work either because of the high debt ratios I just discussed. At current debt-to-GDP ratios, each additional Dollar spent yields less than a Dollar of growth. But because it must be borrowed, it does add a Dollar to the debt. Debt becomes an actual drag on growth.

No one can say when the clock will strike midnight – people have been warning about an impending collapse for decades, and it hasn't happened.

Many have seen that as a license to keep going deeper into debt, as if it can continue forever. Well, it can't go on forever.

And the more debt we add, the faster the day of reckoning will arrive.

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