To The Moon

Are you concerned about the US Debt Limit saga that is bubbling stronger each passing day and is threatening to overflow ?

I am concerned because US stock market may be affected in the process.

Once Upon A Time…

In Jan 2023, US Treasury Secretary Ms Janet Yellen has announced that the US government has hit its legal $31.4 Trillion debt limit.

The US Treasury dept is expected to continue to use its cash balance and apply “extraordinary measures” as long as it can to meet its payment obligations.

Unfortunately, the “extraordinary measures” will not last forever.

US Treasury dept is expected to run out of money by 01 Jun 2023 and will not be able to meet its financial obligations after that.

In the meantime, US Congress is faced with overcoming political gridlock to address the Limit before time runs out.

What Is US’s Debt Limit?

Everyone has bills to pay.

The US government is no exceptions.

Examples of government payment includes:

• Military salaries.

• Retiree benefits.

• Interests on national debt etc…

One way to fund its expenses is for Treasury dept to borrow money from the public by issuing bonds (ie. issue new debt) to investors - both local & international.

The main reason why US Treasury dept sell bonds is because the US government consistently runs into budget deficit.

Meaning each incumbent government spends more than it earns / takes in.

US the country has been caught in a vicious cycle of spending and issuing Treasury bonds to finance its spending for the longest time.

“Luckily” there exists the “Debt Limit” that sets the maximum amount the US government could borrow.

The latest revised limit stands at $31.4 Trillion.

The Debt Limit cap was introduced and implemented in 1917.

Since World War II, statistically the Limit has been raised or suspended 102 times – the last time being 2021.

What Happens Next?

The US government body - the US Congress (House of Representative and Senate) is in charge of suspending or raising the limit.

In the coming weeks, members from both political parties (Democrats & Republicans) will be sparring with each other to work out a deal on the Debt Limit with each party demanding the other to make concessions.

Are they really working on a deal that is good for the country and its citizens? I don’t think so.

It is more about scoring points (laying the groundwork) in preparation for the next general election.

If it is really for the good of the US citizens, why is every incoming President (or Party) spending more and more than its takings?

Is leaving the United States in mountains of debt doing the country any good in the past, present and future? Personally, could you afford to run your household in perpetual debt?

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What If Debt Limit Cannot Be Resolved?

• Risk of payment default becomes a reality (no money to pay).

• Expects Treasury to prioritize paying its debt obligations first in order to maintain its “global” credit rating, while curbing its discretionary expenditures (like education and transportation).

• The impact could be an economic disaster both locally (obviously) and globally (due to US’s influence).

Past Incident & Fallout Consequences

Although there has never been an incident in US history where the Debt Limit issue was not resolved, there existed one in August 2011 where the Limit issue was compromised and signoff - 2 days before Treasury’s estimated funds ran dry.

The backdrop is uncannily similar now as it was back in the Summer of 2011:

• The House of Representatives was majority controlled by the Republican Party.

• The Senate was majority controlled by the Democratic Party.

• The White House running President Mr Barack Obama is Democratic Party.

• The Vice President in-charge of the negotiation with the House of Representatives was none other than Mr Joe Biden himself. Isn’t it ironic & poignant at the same time ?

Despite the ruling government negotiated and gave into the demands set out by the House of Representatives and the Debt Limit was revised upwards, damages were done.

1) Stock Market Collapsed.

• The stock market plunged as the deadline to Treasury dept running out of money drew nearer and nearer.

• Despite the debt limit was raised “higher” at the eleventh hour, US market continued its downwards spiral for a further 2 months before staging a recovery.

• One thing to note - in 2011, (a) US economy was not inflationary and (b) there was no active war in the world that US is “sponsoring”.

2) US Credit Rating Downgraded

• For the first time in US history, its credit rating was downgraded by Standards & Poors

• It went from AAA (Triple A) to AA+

• S&P credit rating is one of the most important indicators of (i) financial health and (ii) categorizes a government’s “creditworthiness,” or the extent to which it is worth trusting to pay back debts to a lender.

• As of 9 Mar 2022, the US government never did get back its Triple AAA credit rating.

3) Other Damages US Suffered

• US dollar sold off. Looking at above exchange rate between US and Euro dollars. The slip started from 01 Aug 2011. It finally bottomed on 16 Jul 2012 before staging a recovery.

• Credit spreads widened.

• Higher interest rates.

• Millions of job losses. Would this plunge the US economy into a full fledge recession instead of the “mild” recession predicted in H2 2023 ?

• Major hit to US’s GDP; that is already coming in lower at 1.1% for Q1 2023.

My View

• The impending negotiation between the 2 parties will be a tough one because I think neither party will back down and make concessions. More importantly, neither party would want to come across as “weak” party to the general public.

• Mr Biden has already made his stance very clear earlier on based on lesson learnt from the 2011 saga where he experienced first-hand the damages inflicted on the US economy. He said that “I will not let anyone use the full faith and credit of the United States as a bargaining chip”.

Latest news on 02 May 2023

• With the latest “warning” from US Treasury Secretary dating 02 May 2023, there is only about 3 weeks plus left to settle the debt limit incident.

• The probability of a stalemate is much higher now, with an accompanying political agenda thrown into the mix.

Lastly, whichever party comes out of the negotiation with a “better” win/compromise; I really hope it is not at the expense of the possible fallout experienced in 2011 (mentioned above) happening all over again in 2023.

• Do you think that the debt limit issue could be resolved amicably ?

• Do you think the issue could be resolved as early as possible or as late; reminiscent of 2011 all over again ?

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