The Debt Ceiling Could Bring the Market to new Lows
Garrett Baldwin said it yesterday morning – “the United States government is officially out of money.”
Treasury Secretary Janet Yellen said she’ll be able to take “extraordinary measures” to help fund government operations and service our $31 trillion debt, but as of yesterday, but Uncle Sam can’t borrow anymore.
Yellen can pull some strings to keep the lights on until June, but as of this past Thursday we’ve hit that infamous debt ceiling (again.)
I’m going to show you exactly what’s going on here, and why I think this could be the catalyst the market needs to find its true bottom.
it’s important to understand the term “debt ceiling.”
Simply put, it’s the maximum amount of money the U.S. government is allowed to borrow to pay for its obligations, such as Social Security, Medicare, military and civil service salaries, and any other obligations they have to stay a country
Once the government reaches this debt limit, there’s no more ability to borrow, and all the things I just mentioned, and a lot more, can no longer be funded. They begin to shut down because there’s just no money to run them.
The usual question when this happens is: What’s the point of the debt limit if the government can just print as much money as it wants to?
Well, there is a very interesting answer to that question…
Prior to 1917, Congress was in charge of all government spending…
So, if there was a war, infrastructure upgrades or repairs, or any other form of investment the government needed to make, they would take a vote on the measure and budget accordingly.
But to provide a bit more flexibility to spending during World War I, Congress passed the Second Liberty Bond Act, which put a limit on how many bonds could be created and how much money could be spent.
It’s essentially the government’s credit card, so it could spend as needed without too much oversight or procedural hassle up to a set credit limit.
This is why the U.S. government has a credit rating from agencies like Moody’s and Standard & Poor’s; it lets prospective lenders (like other countries) know how likely Uncle Sam is to service his debt. (Shocker: our credit rating is outstanding.)
This is partly why the dollar is the reserve currency in most other countries.
As good as that sounds, the government keeps spending more and more money, so over time Congress needs to raise that limit.
That brings us to today. Once again, the debt ceiling is in play in Congress, and once again, the U.S. economy – and by extension the global economy – is hanging in the balance.
If the debt ceiling isn’t raised, come June 2023 when Yellen’s “extraordinary measures” no longer work, there’s a very real risk the government will be unable to service its debt, which would lead to a first-ever default. That would unleash chaos in the global economy.
Even though we have never defaulted, in 2011 we came so close that the U.S. credit rating was downgraded. At the time, markets got spooked; the Nasdaq-100 (NDX), S&P 500 (SPY), and the Dow Jones Industrial Average (DJI) all dropped by 5-7%.
Today, because we hold the largest amount of debt for any country with our credit rating, we run the risk of default and being left unable to pay our debts as agreed.
This could spur another downgrade to the government’s credit rating – one that could have markets go 5% to 7% lower, similar to what we saw in 2011. And to be clear, I’m not talking about an actual default; this drop would happen if we even come close to defaulting.
That is just if we get close to defaulting…
In the highly unlikely event, Congress can’t agree to come to terms, and the Treasury misses a payment, a credit downgrade would be the least of our worries; the fallout from a default would absolutely devastate the market
In a prolonged default on our payments, we would see millions of jobs lost, trillions lost in household wealth due to the market crash, and interest rate spikes, and that is just scratching the surface
Loans to the U.S. would no longer be considered risk-free, meaning interest payments on that debt would go up substantially…
Look, I don’t think a default is actually likely, so I’m not worried. But investors could still end up with a less-than-ideal situation.
Now, as I said, the Treasury will resort to extraordinary measures to stay afloat until this coming June – but in the short term, investors are going to start pricing in the slim, slim chance that the government defaults on their debt.
They have until June to sort this all out with the extraordinary measure in place.
But as time gets closer, if expectations of a default increase, we could see a repeat of 2011 with a 5 to 7% drop in all the major indexes.
You’ll be able to capitalize on this because of the market supercycle. Bonds will be the first thing to go; if they start slipping, it’s likely the bond traders see something we don’t.
You can watch this using tickers such as iShares iBoxx $ High-Yield Corporate Bond ETF (HYG) and Treasury Yield 10-Year Index ($TNX).
When these start to slip, you can feel safe about betting that everything that can go down, will.
The U.S. dollar, bonds, consumer discretionary, and even consumer staple stocks will tank; our dollars will be worth less, getting crushed at a time when dollars are already stretched mighty thin.
This will be on my radar for months to come until the impasse is resolved that is. I won’t be alone, of course. Garrett Baldwin lives and breathes macroeconomics; I wouldn’t be surprised if he tracks the debt crisis in his dreams. You can my updates here and on my show, and you can hear from Garrett at MiddayMomentum.com.
Enjoy your weekend. I’ll see you all first thing Monday morning!
Comments
January 20 2023
