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Kicking the Can down the Road - Outside View by Chirag Mehta
 
 
Kicking the Can down the Road

The U.S. debt ceiling debate has dominated the headlines over the past month. It brought with it a number of disagreements and issues regarding the debt, since August 2nd 2011 is considered the deadline for raising the debt ceiling and creating a bill, forgoing which, the United States government is expected to begin a process of default.

As we move closer to the finish line, we see that President Obama has been able to push through a compromise which is a short term solution also akin to "kicking the can down the road". The debt limit is proposed to be raised by at least $2.1 trillion against the promised reduction in government spending of $2.4 trillion over 10 years, which will buy the government time for the next couple of years. Without a debt limit increase, the Treasury department's accounting pretense would run out and the U.S. will enter into technical default. Without congressional agreement to increase the debt limit, the U.S. government will be unable to borrow money which would be used to cover payments, including Social Security checks being sent out to 50 million recipients on August 3rd, and interest payments on U.S. government bonds which are due later in the month.

A look at the U.S. debt

The first question that you may ask is, "Why the sudden focus on the federal debt ceiling?"

Let us start by defining debt ceiling. It is the level of government borrowing acceptable by Congress. You may think of it as the government's credit card limit which is almost maxed out. The current debt ceiling stands at $14.294 Trillion (before the increase), and this is the amount of money the government is legally allowed to borrow to fund all its functions - from defense to education to entitlement programs.

The issue
The Congress has voted 10 times in past decade to raise the debt ceiling, without much ruckus, then why has the voting become a big issue this time around?

As the common financial adage goes "This time is different", the debt has already reached unsustainable levels and the U.S. government has been running deficits year over year attracting criticism from all around. The Republicans were refusing to vote for an increase in the debt ceiling unless the Obama administration agrees to big spending cuts or at least come up with tough restrictions on future spending. And according to the White House, such a debt ceiling vote should be separate from the budget debate. Failure to raise the debt ceiling could cause the government to default on its debt payments, a one of its kind in the U.S. history.

Unlike the previous debt ceiling votes, the Republican lawmakers were at a disagreement with the Democrats and the Obama Administration this time, making such voting extremely crucial to decide U.S.'s economic position. The Democrats believe that there is an urgency to raise taxes in order to balance the budget. In reality, the American economy produces $15 trillion in GDP per annum but has $115 trillion in unfunded liabilities. With a gap like that, no amount of taxes could bring stability to the budget.

If the U.S. were to raise their revenue from 14% of GDP, as it is today, to 20% in 2000, it would barely make a dent towards funding their Social Security and Medicare liabilities. Therefore instead, they should reduce their entitlement spending instead of raising taxes. However, the Democrats refused to face such facts and were reluctant on reducing entitlements without raising taxes on the rich, while the Republicans were averse to raising taxes when the unemployment rate is 9.2%. This is where the deadlock remained unresolved, and anyone who expected a significant deal to cut more than $4 trillion in spending, was severely disappointed.

The Hype
After outright failure to warn investors of the dangers associated with the toxic debt of entities like Fannie Mae, Freddie Mac and AIG, as well as the hazards of investing in mortgage-backed securities and sovereign debt of various bankrupt countries, the credit rating agencies have now apparently decided to be more vigilant. The criticism of their failure has resulted in them voicing concern over the U.S. debt rating being lowered, if Washington failed to make progress on its fiscal disparity. However, the misconception of these rating agencies' fiscal caution was reflected in Moody's suggestion of complete elimination of the debt ceiling as the ideal solution! In other words, Moody's believes that the nation's problems are more political than a persistent, unresolved, problem of borrowing more than can ever be repaid.

The possibility
The bond market was not expecting any major disruptions in the U.S. debt story, either because investors believed a deal will be reached by the deadline or because they did not feel that failure to reach a deal will have the dramatic repercussions feared.

Debt ceiling issues have also occurred in the past but have escaped easily. In early 1996, Bill Clinton warned that because the debt ceiling had not been raised, Social Security cheques might be delayed. This statement pushed Congress into passing a small increase in the debt ceiling solely to meet Social Security payments. The Treasury could acquire considerable additional borrowing room by not issuing non-marketable debt to the Social Security and Medicare Trust funds and by failing to rollover existing issues as they become due and issuing IOUs in their place, just the way it does with the civil-service pension funds. While the Treasury seems to have rejected issuing IOUs in place of civil-service pension funds, it does not seem to be legally off limits. Keeping such observations in mind, it seems that if Tim Geithner had to make a choice, he would prioritize bond interest. Failure to pay Social Security cheques or any other payment on time would cause hardship to recipients, provoke a public backlash against the administration, and bring embarrassment for the United States. After all, how can the world's most powerful economy not pay its bills on time? It is to be understood that even a small default would result in on widespread criticism.

The outcome
As anticipated, President Obama's last minute deal to increase the debt ceiling with very little in agreed spending cuts was approved by the House of Representatives. Now, the federal government has pulled the deal just in time to raise the U.S. debt limit by at least $2.1 trillion and cut federal spending by $2.4 trillion or more. Still, there hasn't been a real solution to the mess that U.S. finances are in. With such an outcome, the credit rating agencies may follow through on their promise to downgrade the U.S. sovereign debt.

However, it is good to know that there have been measures taken to cut government spending, which otherwise would have received a massive debt downgrade from its foreign creditors.

Nevertheless, there has not been any long term solution for U.S. finances. This increase just buys some time and without any major breakthrough, the same issue would recur in just a couple of years down the line. The federal government now has to borrow about 40 cents of every dollar it spends meaning that it is unable to meet 40% of its obligations! Such debt would cause economic panic, trigger litigation, and eventually raise doubts about its ability to meet any commitments.

The real issue
Unfortunately, the privileged American leaders are engaged in robbing the working class people of the U.S. Let us take the example of the bank bailout of 2008-2009, when the financial elite conveniently passed its bad debts and losses created from years of reckless speculation, to the federal government to clean up. Now the working class is being compelled to pay the price for the misdoings of the Wall Street chiefs by the destruction of Social Security, Medicare, Medicaid and other social programs in education, the environment, transportation and housing.

After the voting that swayed towards increasing the US credit limit, the Obama government can breathe a sigh of relief as they get more time in hand to form more programs. But, one should examine what Barack Obama, John Boehner and other political and media representatives of big business stated less than three years ago, when they declared that "there is no money" to sustain vital programs on which tens of millions of working people depended for their survival. Why weren't such suggestions of "there is no money" made when they planned to save the banks from collapse? On the contrary, staggering sums, as much as $23.7 trillion in combined cash, loans and guarantees from the Treasury, Federal Reserve and other institutions - were made available to defend the capitalist system and the financial interests of the super-rich.

The government also went on to say that if this deadline was missed, they would not be able to guarantee that Social Security cheques would go out as planned. Such a statement demonstrates that in the event of a new financial crisis, the divide between the rich and poor would magnify even more remarkably. This reveals the true character of the Obama administration. It is a government of, by and for the financial riches where without even a sight of threat, the wealthy would continue to be well paid.

Under such circumstances, the first step in this struggle is for the working people of the U.S. to break politically with the corporate-controlled politics and fight for the building of a mass socialist movement. It is important that the government's current size be cut down and strict reforms be brought in place for unproductive government spending.

The graph below reveals how gold has performed against the U.S. debt limit and given such attitude towards policy making, gold is the only hedge against the evils of such scheming governments.

Chart: Gold ($/oz.) and US debt limit ($ trillions)
Source: Bloomberg

Chirag Mehta is Fund Manager, Commodities for Quantum Mutual Fund and manages the Quantum Gold Fund ETF and the Quantum Gold Savings Fund among others.

Disclaimer:
The views expressed in this Article are the personal views of the author Chirag Mehta and not views of Quantum Asset Management Company Private Limited(AMC), Quantum Trustee Company Private Limited (Trustee) and Quantum Mutual Fund (Fund). The AMC, Trustee and the Fund may or may not have the same view and DO not endorse this view.

 

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