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The U.S. Treasury Secretary warns of
dire consequences if the debt ceiling is not raised. And yet investors are
buying bonds, not selling them. Why?
Here is a blast from the past for you:
A specter
that has been putting in an appearance more or less regularly every year now
since 1953 is again back to haunt the Administration. That is the problem of
keeping the public debt within the debt ceiling -- a problem that will be
additionally complicated in the present fiscal year by the prospect of a very
substantial budget deficit...
With the debt pressing against the
ceiling, as a result of [sic] post-Korean rearmament program, President
Eisenhower proposed in 1953 that the Government be given more elbow room in
meeting its finance requirements, but Congress put its foot down. The great
problem of the Treasury that year and in years since then has been to get
past the lean period of the year, from December through February, when
receipts are at their lowest. This has been "solved" since 1953 by
authorizing temporary increases, usually of $5 billion, in the ceiling. In
the face of the much more serious situation that it now faces the
Administration is proposing that the present debt limit be raised to $285
billion, with an additional $3 billion on a temporary basis...
-- The New York Times, July
26th, 1958
The more things change the more they
stay the same, eh?
And yet how about those numbers? Half
a century later, a "temporary increase" of $5 billion would do the
trick for 48 hours. An "additional $3 billion" would fail to cover
a single day.
The debt ceiling has been a point of
contention from 1940 onward. But as the above chart shows (hat tip to The Big
Picture blog), the party really got going in the 1980s. Then, circa 1993, all
hell broke loose.
The debt ceiling is a hot topic
because we are once again pressed against it. Whenever this happens, a sort
of kabuki theatre takes place between Republicans and Democrats. The party in
power thunders about how irresponsible it would be to let the debt ceiling go
unraised. The party out of power volleys back with
accusations of out-of-control spending. Then some kind of deal is struck at
the last minute.
The warnings have been extra shrill
this time around. "Turbo Timmy" Geithner, the Wall Street sycophant
ensconced as Treasury Secretary, has been talking of fiscal Armageddon if the
Republicans don't cave.
"Even a short-term default could cause irrevocable damage to the
American economy," says Turbo Tim.
To which Wall Street has responded:
"Whatever."
The logic seems straightforward. If
America is in danger of defaulting on its debt, and the U.S. Treasury
Secretary is going around like Chicken Little talking about "irrevocable
damage" as Republicans refuse to budge, one would expect U.S. Treasury bonds to be falling -- if not
plummeting! -- in price.
And yet even as I write to you, treasuries
are hitting their highest levels of the year thus far. Bonds are going UP,
not down.
In the midst of the debt-ceiling
melodrama, investors are buying U.S. treasuries aggressively. What gives?
Why, you ask? First of all, no one
believes Geithner's "irrevocable damage" nonsense. It is important
to understand the following:
·
A government that owns a printing
press -- and issues debt in its own paper -- can never be "broke"
in the traditional manner that entities without this privilege can be broke.
·
For lack of better alternatives,
foreign central banks are still net buyers of Treasuries after all this time.
·
U.S. Treasury bonds are still a
top-shelf hiding place in the event of "risk off" market decline.
·
The U.S. government has means to keep
making interest-rate payments even if the debt-ceiling deadline passes. There
are funds available, and other funds can be shifted
around. Geithner is full of hot air, as usual.
·
The true threat to America's fiscal
health is not short-term default or "running out of money." It is
long-term inflation and erosion of purchasing power via monetization of debt.
It is critical to understand the first
point, so let us say it again: A government that owns a printing press
cannot go broke. Not in the way that the man in the street understands
"broke," anyway.
The United States government issues
U.S. Treasury bonds. It also prints up dollars. The interest on the bonds is
paid for with printed dollars. If need be, the government can print up more
dollars -- as many as it wants. The Federal Reserve does not even need ink!
It prints with the push of a button and the whiz of electrons across a
screen. As the modern monetary theorists like to say, Uncle Sam is like the
Monopoly banker who can never run out of money.
So Uncle Sam can't go
"broke" in anything like the normal meaning of the phrase. But what
Uncle Sam CAN do is permanently erode the value of
the currency through inflation.
Here is how it happens:
·
As the U.S. debt mountain gets bigger,
the interest payments on the debt get bigger. Eventually the payments become
too painful, and Washington "cheats" by paying in freshly printed
dollars.
·
This "cheating" sharply
increases the supply of dollars in circulation. If too many dollars are
printed up to make interest payments on the debt, then the value of those
dollars declines rapidly.
·
If the value of dollars declines
sharply enough, or for a long enough period of time, you get sharply rising
inflation, which can eventually bring about catastrophic consequences.
·
At no point does the government ever
"run out of money." It can't. The existing supply of currency, via
mass printing to cover monetization of debt, is simply turned into confetti
instead.
This is how "printing press"
countries that borrow in their own paper go broke: not through traditional
bankruptcy means, but by eroding the purchasing power of their currency over
time.
The above also explains why some think
the debt ceiling should NOT be raised -- that the risk of "technical
default" should be embraced instead, as the lesser of two evils.
The logic here is that a short-term
suspension of payments would cause a bearable load of pain now, whereas
continuing to spend willy-nilly would cause unbearable pain in future -- and
that Treasury-bond investors would understand this trade-off.
Stan Druckenmiller,
the one-time protégéof George Soros
(and multi-billionaire trading legend in his own right), puts it like this in
a rare Wall Street Journal interview:
"Here are your two options: piece
of paper number one -- let's just call it a 10-year Treasury. So I own this
piece of paper. I get an income stream obviously over 10 years . . . and one
of my interest payments is going to be delayed, I don't know, six days, eight
days, 15 days, but I know I'm going to get it. There's not a doubt in my mind
that it's not going to pay, but it's going to be delayed. But in exchange for
that, let's suppose I know I'm going to get massive cuts in entitlements and
the government is going to get their house in order so my payments seven,
eight, nine, 10 years out are much more assured," he says.
Then there's "piece of paper
number two," he says, under a scenario in which the debt limit is
quickly raised to avoid any possible disruption in payments. "I don't
have to wait six, eight, or 10 days for one of my many payments over 10
years. I get it on time. But we're going to continue to pile up trillions of
dollars of debt and I may have a Greek situation on my hands in six or seven
years. Now as an owner, which piece of paper do I want to own? To me it's a
no-brainer. It's piece of paper number one."
Technically speaking, we can never
have a "Greek situation" in the United States. That is because Greece borrowed funds in a currency it
can't print. We borrow in our own currency, so we can always print.
But Druckenmiller
knows this and he is making a simplified point: If we keep spending with wild
abandon, at some point investors will no longer want to buy or hold U.S.
debt. Trillions in new dollars will then be printed up to support crashing
bond prices, and the currency will become confetti, leading to runaway
inflation and "de facto" default. (A rose by any other name...)
All the better for
America to man up now, Druckenmiller argues, and
take real strides toward avoiding our long-term inflation waterloo. A near
term wake-up call of technical default might even be worth the risk.
Plus
wouldn't it be fun to see Turbo Timmy squirm...
Justice
Litle
Taipan
Publishing Group
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