Update on Debt Limit: U.S. Will Not Default!

By Victor Sperandeo with the Curmudgeon


There’s been lots of debate last week about the U.S. government defaulting on its debt if the debt ceiling is not raised.  The U.S. Treasury is currently using so-called extraordinary measures to keep the nation’s bills paid, but such maneuvers are expected to run out this summer, perhaps as early as this June. 

We wrote about the debt limit earlier this year, so this post is an update with more legal nuances and analysis.


Market Impact:

This important issue has a great deal of meaning for the markets, as a debt default would cause a crisis and potentially paralyze the U.S. economy. 

The swaps market is very much concerned.  5 Year Credit Default Swaps (CDS) on U.S. debt are priced at 41.96 as of 4/30/2023.  That CDS value changed +38.34% during last week, +3.3% during last month, +174.25% during the last year.  This 1-year CDS graph tells the story loud and clear:

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Source:  World Government Bonds


Executive Summary:

Last week, the GOP led House of Representatives narrowly passed a bill pairing an increase in the nation’s borrowing limit to $1.5 trillion or until March 31, 2024, whichever comes first.  It contains deep cuts in government spending, setting discretionary spending levels for the coming year at fiscal 2022 levels and limit spending growth to no more than 1% a year.  The bill would cut projected government deficits by about $4.8 trillion over 10 years, according to the nonpartisan Congressional Budget Office (CBO).

The GOP maintains that the Democratic-controlled Senate and President Biden are the ones now standing in the way of preventing a debt default.

Democrats say the debt ceiling must be raised with no conditions and that any talks on fiscal policy need to be held separately.

The Biden administration released its own budget earlier this year that relies on tax increases to reduce the deficit.  President Biden won’t engage in talks tying fiscal policy to the debt ceiling and that Congress needed to pass a “clean” debt limit increase.  “That is not negotiable,” said press secretary Karine Jean-Pierre.

Senate Majority Leader Chuck Schumer (D., N.Y.) pronounced the GOP bill dead on arrival in the Senate. Still, he needs 60 votes to advance any plan of his own, and there isn’t enough support for a clean increase at this moment. Senate Republicans have pointed to the House bill as a starting point.

“The House measure will not pass in the Senate,” said Sen. John Kennedy (R., La.). “But I’m hoping that the House having done its job will cause the president to sit down and have an adult conversation with the Speaker (of the House, Kevin McCarthy).”

We estimate the U.S. Treasury’s cash buffer will fall dangerously low ahead of the June 15th estimated tax and quarterly corporate tax payments.  As a result, the Treasury will likely provide additional guidance soon - perhaps as early as next week’s refunding announcement.

Victor’s Analysis:

I believe investors should weigh the complete picture here, especially the legal aspects of a debt default.

Sadly, almost no one believes that the law matters anymore, and that politicians can do anything they want.                                                     

However, all politicians (including the Fed) will protect “the system” -- not the U.S. citizens -- to avoid a crash and change of the establishment that would result from a debt default.

This talk always gets headlines, but after the “Kabuki Theater” battle plays out, the two parties always come to an 11th hour compromise to rescue the system -- largely for their own benefit.

Since 1960, the debt limit has increased 78 separate times! It’s a game like monopoly that never seems to end.

Thereby, what does a default mean? Under the 14th amendment of the constitution, the U.S. can’t legally default.  That means the government must pay the interest on its debt and repay the principal above the current $31.4 trillion debt limit.

U.S. government workers cannot be paid before U.S. debt holders.  Here’s the law:

“The Framers of the 14th Amendment made clear which option he should choose. Section 4 of the Fourteenth Amendment, the “Public Debt Clause,” expressly provides that “[t]he validity of the public debt of the United States, authorized by law, . . . shall not be questioned.”  This broad language makes clear that the country must pay its debts; the failure to do so will call into question the “validity of the public debt” and impair the fiscal integrity of the nation — exactly what the framers of the Fourteenth Amendment were trying to prevent.”

Here’s the math:

·        Estimated net interest to be paid in this fiscal year to date is $562 billion (interest costs represented about 8% of total federal outlays in 2022);

·        U.S. tax revenue is estimated at $4.6 trillion.

-->Therefore, tax receipts will cover interest owed x 8.2 times!

That interest must be legally paid before $1.00 of spending in any other category, including Social Security and Medicare.

What happens to U.S. government workers if the debt ceiling isn’t raised?  

According to the Brookings Institute, Federal employees would likely continue working during a debt-limit impasse in contrast to the government shutdowns that occur when Congress hasn’t enacted appropriations bills. That’s because federal agencies would still have legal authority, provided by Congress, to obligate funds. Thus, national parks and other government agencies would likely remain open, but federal workers’ paychecks would be delayed. 

That would surely create a hardship condition for many government workers and weaken consumer spending.

Cartoon of the Week:

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Cartoon by Jeff Koterba


Relevant Supreme Court Case:

We revert to a major Supreme Court Case in 1884 “Juilliard v Greenman” to highlight that the U.S. can print the money owed! 

In an 8–1 decision resting largely on prior court cases, particularly the jointly-decided cases Knox vs. Lee and Parker vs. Davis, the power "of making the notes of the United States a legal tender in payment of private debts" was interpreted as "included in the power to borrow money and to provide a national currency."

The dissenting Justice Stephen Field mentioned not needing to pay interest in his opinion: “If congress has the power to make the notes a legal tender and to pass as money or its equivalent, why shouldn’t a sufficient amount be issued to pay the bonds of the United States as they mature? WHY PAY INTEREST on the millions of dollars of bonds now due when congress can in one day make the money to pay the principal?”

This case led to the passing of The Federal Reserve Act of 1913, where the U.S. hired private bankers (the Fed) as agents to print money instead of the U.S. Treasury. 

-->That was to effectively hide the conflict of interest problems of loaning money to the political parties, Congress members, and special interests, or friends of the political class.  

Further, the Court’s opinion was Constitutional Law — Legal Tender Notes — Statutes. “Congress has the constitutional power to make the treasury notes of the United States a legal tender in payment of private debts, in time of peace as well as in time of war.”

Under the act of May 31st, 1878, Ch. 146, “any United States legal tender notes may be redeemed or received into the Treasury, and shall belong to the United States, they shall be reissued and paid out again, and kept in circulation, notes so reissued are a legal tender.”

-->Thereby, the U.S. federal government can print money for ANY reason and for ANY purpose!

Victor’s Opinion:

It should be obvious to anyone who can read English that the Juilliard v Greenman case is totally unconstitutional. From the Constitution Article 1 Section 8 clause 5.  (The U.S. government is allowed) “To COIN MONEY, regulate the value thereof and of foreign Coin and fix the Standard of Weights and Measures.

Also, in Section 10 (emphasis added): “No State shall enter into any Treaty, Alliance, or Confederation; grant Letters of Marque and Reprisal; COIN Money; emit Bills of Credit; make anything BUT GOLD AND SILVER COIN a Tender in Payment of Debts; pass any Bill of Attainder, ex post facto Law, or Law impairing the Obligation of Contracts, or grant any Title of Nobility.”

The primary reason the founders of the U.S. did not allow printing paper for money is it leads to extreme amounts of corruption and thereby the END of LIBERTY.

Victor’s Conclusions:

The U.S. will not default on its debt, even if a debt ceiling agreement is not reached.  Since Social Security, Medicare, other social transfer payments and U.S. worker salaries would not be paid on time, we expect an agreement to raise the debt ceiling will be reached before the current “extraordinary measures” run out.

As the U.S. declines further, every week we are approaching the end-game which is hyperinflation.  There are new laws that come from new spending, other laws that are ignored (e.g., selected bank bailouts), Congressional payback to political donors and certain voters who are the friends or beneficiaries of those in power, etc.  In all cases, the Fed provides the freshly printed fiat currency.

End Quote:

From the mind and research of perhaps the greatest U.S. Founding Father:              

“If the American people ever allow private banks to control the issue of their currency first by inflation then by deflation the banks and corporations that will grow up around them will deprive the people of all property until their children wake up homeless on the continent their Fathers conquered... I believe that banking institutions are more dangerous to our liberties than standing armies... The issuing power should be taken from the banks and restored to the people to whom it properly belongs.” 

A person with a flag in the background

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Thomas Jefferson was the draftsman of the U.S. Declaration of Independence, the nation’s first secretary of state (1789–94), second vice president (1797–1801) and third president of the U.S. (1801–09)

Be well, stay healthy, wishing you peace of mind. Till next time…….

The Curmudgeon

Follow the Curmudgeon on Twitter @ajwdct247

Curmudgeon is a retired investment professional.  He has been involved in financial markets since 1968 (yes, he cut his teeth on the 1968-1974 bear market), became an SEC Registered Investment Advisor in 1995, and received the Chartered Financial Analyst designation from AIMR (now CFA Institute) in 1996.  He managed hedged equity and alternative (non-correlated) investment accounts for clients from 1992-2005.

Victor Sperandeo is a historian, economist and financial innovator who has re-invented himself and the companies he's owned (since 1971) to profit in the ever changing and arcane world of markets, economies, and government policies.  Victor started his Wall Street career in 1966 and began trading for a living in 1968. As President and CEO of Alpha Financial Technologies LLC, Sperandeo oversees the firm's research and development platform, which is used to create innovative solutions for different futures markets, risk parameters and other factors.

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