By Relmor Demitrius -
On August 2nd, the United States current allotment of lending ability to fund its operations will be reached. It will then need to make immediate spending cuts. They wouldn’t even be allowed to borrowed from the Federal Reserve, which can print dollars and sell them to the Treasury for bonds, because they wouldn’t be allowed to borrow money from anyone, period. Why it’s called a debt ceiling, and not a debt squooshy thing that is flexible. When the Fed does buys bonds, this is called “monetary dilution” and erodes the underlying value of the dollar. China, Japan, and private investors of course make up a percentage of this, and is the true “market demand for US Debt”. The Federal Reserve is filling a need by the amount they lend. This is dilutive to the value of the dollar. It’s the Fed borrowing aspect of the continuing funding of running a deficit that is the true criminal in our dollar erosion and loss os spending power, which has sent gold and silver to record highs this year. That is how you know what is really going on.
What is gold doing? Why is oil lagging? Because oil is not a reflection of monetary responsiblity directly, gold is. Oil goes up if the amount of dollars in the system increase, not if the “perception of the value” of the dollar changes. That would reflect more in the gold/silver aspect of the commodity family. Not saying the price of oil in dollars isn’t sensitive to all aspects of the underlying currency it is being brought to market in, but there are many other affects on the price of oil outside of simple monetary policy. Whereas gold and silver, as a representation of real money, is a much better indicator.
In a way this is proof of what is happening long term to our country and dollar. The inflation needed to pay the interest on our debt is becoming more and more, making it harder and harder to get value and cheap dollars to the banks and those who need it to fund economic growth. Banks are not motivated at 4% interest rates to loan out money. Sure its cheap, but when a 30 year bond is paying 4.4% interest, you are not going to get a lot of banks willing to loan money out until interest rates are higher. Best way to do that is to make sure the government has all the money it needs to fund its current budget and keep interest rates from sky rocketing beyond what consumer demand can absorb. It’s a tight rope and one the Fed has had to skillfully walk for generations now. It’s not easy and often abused. For instance, in the early 2000′s, Greenspan kept Federal lending rates way too low way too long. The economy did not need it and it created a large amount of leveragable M3 money (fake money) that had to go somewhere. You never want inflation to grow faster than there are places to put it. That’s bad and you see the effects still to this day.
So by not raising the debt ceiling, the government is enacting a currency strengthening policy that is very bullish the dollar. It would say the government is overspending and we are so incompetent we are going to let highest need first solve where we need to divert money. Interest on debt will of course be paid first. They would never risk an outright default. We are not going to borrow from the Federal Reserve, (Remember it doesn’t matter who lends the government the money, as long as it keeps coming in), we are going to make drastic spending cuts so we can keep our interest payment going to our current debtors and no longer take on more debt. This would limit supply of current treasuries, sending the prices skyrocketing. It would make these bonds very valuable and send rates even lower. The dollar would make a huge rally and the market would tank accordingly. Traders would exit their positions and some long term money managers may start scaling back equities and back into bonds.
By raising the debt limit, the stock market will know that the dollar erosion long term play is still valid. Bond prices would drop, but since it’s expected, not much. This bond drop will occur slowly, in my opinion, over time. As the government can issue new treasuries now, supply will be increased sending bond prices down, and interest rates up slightly. Banks will like this. They will get a better spread on their lending abilities and mortgage rates would probably bottom shortly. This would allow money to get back into the system and the boom bust cycle can continue.
The consequences of not raising the debt ceiling would be up to 2 years of pain. After that our country would have better footing and prompt more home-grown manufacturing as the value of the dollar would be strong. Those in cash would welcome this. Those in dollar backed assets would not like this.
The consequences of raising the debt ceiling would allow the normal inflation cycle to continue. If we cut spending slowly we can limit the negative effects of dollar erossion. This is what we will probably do.
Overall, I want the debt ceiling to be raised, but I want the government to cut spending as well. I do not want more taxes however. If they lowered taxes and lowered spending even more than that, the effect on the economy would be dramatic and the dollar might actually stabilize while the market rose. That would be good for all.
Our government has to borrow 40 cents for every dollar they spend. Think about that. This is directly from Geithner himself. Remember, by not raising the debt ceiling, the government is saying we cannot pay our current obligations. We can’t take on new debt until we pay off enough of our existing debt, which would mean running a balanced budget and immediately cutting costs like FBI, military, or social security checks. Something has to give if you don’t have enough inflow. Think about it in a personal perspective. If you receive $100 a month income and $40 of that is directly to pay interest on the existing debt, that leaves you with 60 dollars to pay your bills. Here’s the problem. The government needs 80 dollars to pay its bills a month. So what do you do? You don’t pay your bills, which could hurt your credit rating, and someone suffers. No, the government will always pay its interest first on its existing debt, but they need to borrow 20 dollars a month to pay its bills. Your telling them they can no longer do that. They have been doing it for decades and centuries, but now you cannot do it. That would be a harsh jolt to any system and not the answer here. So yes, it would affect our credit rating. Damn skippy it would. With sure fire bets paying such terrible returns, there becomes no place to put your money. I would look to other inflationary markets to put my money if I were a foreign investor. Bonds are not attract at these rates. I can buy a Chinese bond or an Irish bond and get 5%, 6%, or 7% return. Why would I lock up my money for 30 years on a bond that is already expensive historically to buy and paying a crap return as well. Same problem with the shorter term treasuries as well.
So you may ask yourself, why are both parties threatening to not raise it? Because they are using your welfare and money as political leverage against the other. But in the end, neither wants to be responsible for what would happen if the debt ceiling wasn’t raised. That party would have a hard time convincing the American people it would be for their own good. Which it probably would be eventually, or for their kids at least. But when was the last time you saw politicians put the burden of pain on the current generation and not on the next? There would be no precedence for sure.
