The problem of the United States public debt and the unwillingness of Republicans to raise the debt ceiling from the already astronomical $31.4 trillion as we approach June 1 this year are getting investors more and more excited. not this country, but the whole world. US Treasury Secretary Janet Yellen is also fueling the fire by stating that by June 1, the country’s treasury will run out of cash (i.e. not money, cash and non-cash and bonds, which are also taken into account in monetary statistics). ).
There will be nothing to pay on previously issued US government treasury bills, which means default. Yellen argues that it will lead to economic and financial disaster.
The problem of a particular country turning its domestic financial problems back into a global problem stems from the fact that the USA, which did not suffer as much destruction as European countries during the Second World War, could persuade other countries. the whole world, that the national currency is the most stable currency in the world. And therefore, all other countries must abandon the gold standard and switch to the gold exchange standard – the exchange of European currencies for the US dollar, which they promised to exchange for gold. It happened in New Hampshire in 1944, after the signing of the Bretton Woods agreement.
Famous British economist John Maynard Keynes, one of the architects of this monetary system, rightly stated that the world has now become dependent on the printing house of the Federal Reserve System. Looking into the water – in 1971 President Nixon announced that it was impossible for the federal government to exchange the 20 billion “Eurodollars” offered by General De Gaulle for gold – because there weren’t enough. The result was a sharp devaluation of the US currency and a rise in world gold prices from $35 per tr. At comparable prices an ounce went over $2,000. It was the first US default.
The latter may happen in the near future, as the US has been able to convince the entire world that government bonds are paper-like, or a “risk-free asset” that the US redeemed even during the Great Depression. Yes, only you and I were convinced a year ago that this “risk-free asset” cannot be repaid, but simply arrested, as well as government bonds of the European countries with the highest credit ratings. Although now the enforcement officers are brainwashed about how to arrest Russian assets if there is no such legislation. Japan was the first to announce this.
The sanctions, though, thought through their brains and found a way out – the assets themselves are frozen but not yet seized, but it seems possible to collect the interest on them (bond coupon income, income from bank deposit accounts). Over the course of the year, decently billions of dollars increased from the $300 billion in Russian reserves.
Today, another act of drama about the US national debt is being played. The House of Representatives, controlled by the Republican Party led by Donald Trump, demands that the administration learn to live within its means and agree to raise the national debt ceiling only in exchange for an 8% cut in state budget spending. The Democrats, led by Joe Biden, are insisting on raising the ceiling unconditionally and even eliminating the concept of the ceiling.
The problem is that the United States has been running a federal budget deficit for years – defense spending, social goals, health care programs, payouts to civil servants are increasing. One of the traditional items of budget spending has been helping the Allies since the days of President Monroe’s “gunboat diplomacy”. In 1917, when large appropriations were made for the Allies, the United States was required to enact the concept of a “debt ceiling”. But they had to use this limit during the Great Depression in 1939.
Since then, the debt ceiling has been raised more than 100 times, closing the gap with treasury bonds that both domestic and international investors have willingly purchased as a risk-free asset.
But since 2008, after the crisis in the US mortgage loan market, doubtful loans have been repackaged into “risk-free” bonds that are supposedly backed by real estate and quickly snap, with the help of credit derivatives invented by Wall Street investment bankers. The picture of the US debt market, established by European and Japanese pension funds and insurance companies, has changed dramatically.
First, the crisis has hit the whole world and more painfully than the United States itself. Secondly, the largest investors in treasuries gradually began to emerge from them. China, which previously held more than $1.3 trillion in US Treasury bonds, decided to hold only $859 billion in January 2023. Beijing was going to withdraw all its reserves from American securities, but decided to leave some of it as an instrument of pressure should relations with the United States over Taiwan get worse. Having invested nearly $2 trillion in treasury bonds until 2008, Japan dropped its stake to $1.104 trillion in early 2023. England, Belgium and Luxembourg follow them. But oil monarchies in the Persian Gulf have slashed investments in US bonds to insignificant values, giving way to Europe.
The de-dollarization of world reserves and settlements that started in 2022, due to Russia’s decision to sell gas in rubles and the position of China and India to trade in national currencies, also played a role in this process. At the same time, central banks around the world used record amounts of yuan on swap lines with the People’s Bank of China at the end of March – 109 billion yuan (or $15.6 billion), which exceeds the same amount of swaps. The whole of 2022 is 20 billion yuan.
I must say that in August 2011, when there were disagreements about raising the debt ceiling, the USA has already frightened the whole world with a similar situation. It even went as far as a “shutdown” – withholding wages to civil servants and sending them on mandatory leave. As a result, Standard & Poors, the most influential rating agency in the USA, downgraded the credit rating of treasury bonds one notch from AAA to AAA-, and the glow of “paper gold” somehow faded away. However, the price of the physical metal rose from $1,300 per tr to $1,940. While the ounce fell sharply against other currencies, the US dollar also fell sharply. Then default was averted—Barack Obama, lobbying for a free medical care law, agreed to cut government spending by more than $2 trillion over a decade.
And now comes the third act of the “Marleson ballet” – a possible technical default on US government bonds as the Treasury has nothing to pay them, as Yellen admits. Biden said congressional talks would resume after they had previously collapsed. The fact that the American leader did not even cancel his visit to Japan for the G7 summit showed his confidence in the agreement. But the Senate can thwart that – the Biden-led Democrats need a bill that would allow them to raise the debt ceiling without any conditions.
But financial markets don’t quite trust politicians yet: The cost of insurance against defaulting US Treasury bonds has reached a new high amid political infighting and Yellen’s threats to shut down civil servants’ coffers. Credit default swap (CDS) value jumped to 152 basis points, surpassing the April high of 134 basis points, the highest level since the 2008 global financial crisis, and a similar situation occurred in 2011, when CDS prices did not exceed 100 basis points. In general, the cost of default insurance on US government debt is now higher than the CDS on bonds of Greece, Mexico and Brazil, which allow defaults and have a credit rating several times lower than that of the US! This reflects extreme investor concern about the stability of the markets.
Stock markets will suffer anyway: if the national debt ceiling problem is not resolved before June 1, market turmoil will begin, investors will sell their shares in the face of a new financial crisis.
But if a compromise is found, investors will continue to suffer in the long run: cuts in government spending will trigger the much-spoken recession due to the Federal Reserve’s tight monetary policy. And in any case, the Fed has made Treasury debt service more expensive by raising the discount rate, paving the way for a recession not only in the United States, but also in other countries that have had the imprudence of accumulating dollars in dollars.
If politicians fail to reach an agreement on day X, the U.S. Treasury will have to declare a technical default – failure to pay its debts on time. This will likely lead to a lower US credit rating as a borrower and higher borrowing costs, leading to higher gold prices. The Fed will have to raise rates again, making loans more expensive, paving the way for a recession in the economy, not only in production, but also in demand for commodities – oil, gas, metals.
We’re not talking about the actual US default yet. But the delay in the adoption of a bill to increase public debt will force the Ministry of Finance to cut a number of key cash payments for defense and social purposes. 52 million American retirees and millions of unemployed and extended families will suffer.
Meanwhile, ways to disable Congress are also discussed. The most exotic measure seems to be issuing a platinum coin “at the discretion of the Secretary of the Treasury” or “$1 trillion” to pledge to the Fed and receive cash from the US Federal Reserve. Although Yellen called the idea a gimmick, saying the Fed would likely not accept it as collateral, especially since platinum is now half the price of gold. However, the law of the 1990s provides the possibility of issuing such collectible coins. There has already been a similar precedent. In 1953, “gold certificates” were issued to be deposited with the Fed to earn free money while political games were played in Congress. Attempts to issue new “premium” bonds with higher interest rates are also discussed. However, the introduction of new payment instruments increases the money supply and significantly complicates the Fed’s fight against inflation.
The problem is clearly political, not economic. As long as the credibility of US obligations in the world is not completely shaken, they will be able to make new loans to pay off their old debts. But this policy already resembles a typical financial pyramid scheme. Don’t you think so?
The author expresses his personal opinion, which may not coincide with the editors’ position.