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US Debt Ceiling Battle Could Prove Bullish For Gold

Friday January 04, 2013 13:27

While U.S. policymakers delivered a mini fiscal-cliff deal in the final minutes of 2012, many larger issues were not resolved with the last-minute legislation, most significantly government officials failed to address the U.S. debt ceiling limit.

This is a significant factor for gold investors to monitor as the yellow metal has shown great sensitivity to this issue.

First, let's start with a little background. The U.S. Constitution gave Congress the so-called "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.

The debt ceiling is the official limit to allowable borrowing for the U.S. government, which currently stands at about $16.4 trillion.  Economists estimate the debt ceiling needs to be raised by about $1.5 trillion to meet current commitments. While the government already hit that limit at the end of 2012, Treasury Secretary Timothy Geithner is utilizing "extraordinary measures" to buy a little more time—likely until the end of February.

Over the years, as the national debt has increased, the U.S. Treasury has bumped up against this debt limit and Congress has raised the debt ceilings dozens of times. However, in late summer 2011, the battle to raise the debt ceiling sparked a political firestorm that rocked financial markets and took the country to the brink of default and ultimately resulted in a credit downgrade for U.S. sovereign debt.

Nearby gold rallied to its all-time high during that time period.

Is the U.S. headed for a repeat performance in the weeks ahead? Moody's Investors Services has put the U.S. on warning about a potential downgrade to its debt if no long-term deficit reduction deal is reached.

Now that the New Year's parties and initial fiscal cliff rally is over, U.S. policymakers have to face the hard issues of tackling a plan to cut long-term spending, raise additional revenues and agree to a debt limit increase.

"The upcoming negotiations are likely to be even more difficult and contentious than the ones just completed," wrote Nomura economists in an Economics Research note. "Two main principles will shape the upcoming negotiations over the debt limit. Republicans have argued that they will only support an increase that is matched, one-for-one, with spending cuts. This is a demanding standard… On the other hand, President Obama has stated that any future deficit reduction deal will have to be 'balanced' that is, any spending will have to be paired with additional revenues," Nomura economists added.   

Bottom line according to Nomura economists? "These two principles mean that the upcoming negotiations over raising the debt limit will (again) focus on trading off long-term spending cuts for additional revenues. Given the fractured nature of U.S. politics, there is no guarantee of success."

What does this mean for gold? While rallies have been used as selling opportunities in recent weeks, if U.S. policy makers dig their heels in on opposing camps, the stage is set for a possible repeat of the late summer 2011 political battle. That could ultimately be bearish for stocks and bullish for gold, just like in the summer of 2011.

By Kira Brecht, contributing to Kitco.com, follow her on Twitter @KiraBrecht

Disclaimer: The views expressed in this article are those of the author and may not reflect those of Kitco Metals Inc. The author has made every effort to ensure accuracy of information provided; however, neither Kitco Metals Inc. nor the author can guarantee such accuracy. This article is strictly for informational purposes only. It is not a solicitation to make any exchange in precious metal products, commodities, securities or other financial instruments. Kitco Metals Inc. and the author of this article do not accept culpability for losses and/ or damages arising from the use of this publication.

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