Market Analysis - Kira Brecht
Why You Should Care About The Debt Ceiling
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(Kitco News) - Feb 24 – Brace yourself, the "debt ceiling" is back in the news. The nation's current spending limit at $20.1 trillion is set to expire on March 15, unless Congress authorizes to expand it.
Why should gold investors care about the debt ceiling?
Remember 2011?
It was the dramatic debt ceiling standoff in 2011 that helped propel gold prices to their all-time high above $1,900 per ounce. In August 2011 that Standard & Poor's rocked the world markets with a downgrade of the U.S. credit rating. The downgrade came in the wake of the Congressional battle over the debt ceiling, which took the country to the brink of default on its debt obligations. The historic move dealt a sharp blow to the United States' status as an economic superpower.
A quick recap on the debt ceiling: The U.S. Constitution gave Congress the "power of the purse strings," or the ability to control spending and borrowing. Congress is required by federal law to authorize the government to borrow funds needed to pay for current spending outlays, which currently stands at $20.1 trillion. It is noteworthy – that the debt ceiling increase is not for new spending – but for obligations already promised by the government.
March 15: Not a Hard Deadline
The government has before and can take again "extraordinary measures" to avoid default for a couple of months. These include accounting methods like postponing contributions to retirement funds for federal employees. But, that is just would just be a short-term Band-Aid to the issue. But, more importantly, this will refocus attention on the deficit and some new Administration proposals that could actually grow the nation's debt.
The Current Debate
Coming from Wall Street, Treasury Secretary Steven Mnuchin, understands what is at stake with the debt ceiling issue.
What's at risk: Failing to make payments on Treasury debt would wreak havoc with the United States' credibility as a debtor nation and call into question the ability to borrow the vast sums of money that it needs to borrow at currently low levels of interest. It would also potentially pull the rug on the U.S. dollar as the world's reserve currency.
Repayment on debt is not a trifling matter. Fortunately, Mnuchin has said that making Treasury debt payments is a "critical commitment."
However, despite Republican control of Congress and the White House, there remains within the Republican Party some deficit hawks who could reemerge to fight back against increased outlays from the government. Many of the new president's proposals have the potential to increase the nation's debt.
Cutting Corporate Tax Rate
One example is the President Trump's proposal to slash corporate taxes in the United Sates. Tax cuts won't pay for themselves, and unless there is some proposal to bring in fresh revenue that means a higher deficit.
Here's a look at the numbers:
- The top U.S. corporate tax rate currently stands at 35%.
- President Trump has proposed a plan that would slash the statutory tax rate to 15%.
If the Trump Administration proposal passes as a pure tax cut – without any offset to increase revenues – that means a bigger federal deficit. The current U.S. debt is nearly $20 trillion right now.
Those numbers only include the corporate side of the picture and doesn't include his tax cut proposals for individuals.
A number of groups from the right-leaning Tax Foundation to Moody's Analytics have analyzed the total Trump tax plan and all concluded that it would fail to pay for itself. Projected deficits ranged from $2.6 trillion by the right-leaning Tax Foundation to more than $10 trillion, according to Moody's.
What are the potential consequences of these rising debt levels?
- Down the road, Congress may have to significantly raise taxes to pay for the rising debt, or significantly cut back on spending.
- At some point, could foreigners become reluctant to purchase U.S. Treasury debt to finance the rising tab? (This could trigger bond prices to fall and interest rates to rise sharply).
Rising Deficits Are Bullish For Gold
At the end of the day rising debt levels degrades the value of the U.S. currency. This compares to the intrinsic value of the gold with no counterparty risk. Here is what Alan Greenspan, Chairman of the Federal Reserve from 1987 to 2006, said in the February 2017 issue of the Gold Investor:
"I view gold as the primary global currency. It is the only currency, along with silver, that does not require a counterparty signature…No one refuses gold as payment to discharge an obligation."
The former Fed chair added: "Credit instruments and fiat currency depend on the credit worthiness of a counterparty…Gold, along with silver, is one of the only currencies that has an intrinsic value. It has always seen that way. No one questions its value."
As governments ultimately devalue their currency's purchasing power by taking on greater amounts of debt, gold is an investment that retains its value and is not vulnerable to the whims of a government printing press, or rising debt levels.
Read more: Why The Stock Market Is Really Rallying Right Now
