Why The US Debt Ceiling Limit is an Economic Time Bomb

US debt ceiling, small-caps

 

Trump was all set to head down to the warmer climes of his holiday house in Mar-a-Lago to bask in the glow of his first year anniversary.

Instead he’s stuck in sub-zero Washington DC.

A freeze in budget negotiations over the weekend has shut down the US government.

Government shut downs are nothing new in the US.  It’s a by-product of their unique legislative system, where several branches keep tabs on each other by passing budgets.

In this case they couldn’t get the required majority to pass the current spending bill. And without a spending bill in place, they can’t pay government employees.

This has happened many times before. There were seven shutdowns under the much-vaunted Regan presidency.

But it’s the first time since the 70s that it’s occurred when one party — in this case the Republicans — had control over the White House, the congress and the senate.

Now, this isn’t Armageddon.

At least not for the US economy.

And the record setting markets seem to have shrugged it off so far.

You see, as apocalyptic as the phrase ‘government shutdown’ sounds, it’s not so bad. The shutdown mainly hits non-essential services, resulting in a few closed national parks and monuments. Big things like social security and the military go on as usual.

Of course, it’s still bad news for Trump, whose approval rating is at a low 36%.

Today, the spin doctors are out in force for the two major parties, trying to blame each other. But history tells us it’s usually the ones in charge who cop the majority of the blame.

Something oppositions know all too well. That means there’s always an incentive for them to create an impression of chaos if they can. Consequences be damned!

It’s not a great outcome for you and I, though.

The grandstanding and political games might be entertaining, but the repercussions in the next shutdown could be far greater.

Especially when the trigger for it is a lot more important.

Let me explain… 

The ticking time bomb at the heart of the US economy

As I said, the current shutdown is to do with passing a spending bill.

In other words, the money is there, but they can’t agree how to allocate it.

A bigger issue — and this was the cause of the Obama administration shutdown in 2013 — is when the US debt ceiling is hit.

The limit currently stands at $20.4 trillion dollars.

And due to the unbalanced US government books, it gets closer to this figure every month.

During a debt ceiling standoff in 2011, the United States came perilously close to a default and the stock market took its largest plunge since the 2008 financial crisis.

The rating agency Standard & Poor’s downgraded the US’ credit rating for the first time in history.

To be clear, this is an artificially imposed limit.

The intention is to keep government spending capped. Or at least highlight the levels of spending.

You might as well try to outlaw gravity.

So instead, every so often, you need to have this administrative charade whereby the debt ceiling has to go up.

Trouble is, that leaves a huge hostage to fortune.

Whoever is in opposition can use the debt ceiling as political leverage. As I said before, the incumbent usually cops the political flak for any sort of government disorder. A fact, oppositions seem to use this all the time.

There’s no benefit to them in helping the government govern.

A major economic shock for global economy

If the debt ceiling doesn’t get raised, it means the US government can’t borrow more money. The risk then is that the Treasury might run out of money and literally be unable to make payments on US Treasury bonds.

That’s the US government defaulting to every other nation, most notably China.

Now that’s a crisis point…

If the world loses faith in the credit of the US dollar, what then?

What can the world turn to as a trusted medium of exchange and store of value?

Gold? Bitcoin? Commodities?

It’s would certainly provide a major economic shock. In a world of record markets, it could be the trigger for a very steep decline.

That’s why in my opinion the debt ceiling is the more important of the two ‘shutdown’ triggers. The current spending bill trigger is mainly a matter of priorities and politics.

But the debt ceiling limit is an economic time bomb. It can’t go up forever.

The end game here is a lot scarier.

For your diary, it looks like the money runs out — and the debt ceiling will be hit — perhaps in early April, or even March.

Kind regards,

Ryan Dinse,
Editor, Money Morning

Ryan Dinse

Ryan Dinse

Ryan Dinse is an editor at Money Morning. With an academic background in economics, he believes that the key to making good investments is investing appropriately at each stage of the economic cycle.

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