Who Wins and Who Loses in Government Shutdown and Debt Ceiling Battles?

by The Curmudgeon

Privileged Few "Government" Workers Get Paid During Shutdown:


Last week, the U.S. Congress failed to reach an agreement on the budget for the current fiscal year, triggering the first partial government shutdown in nearly two decades on October 1st.  That put many federal government employees out of work. "91% of the IRS Has Been Furloughed... was the title of a blog post by Tyler Durden.

But ironically, Congressmen/women are still getting paid. They will continue to earn their $174,000 annual salaries.  The Huffington Post published a very interesting article (with embedded video) on this important topic. It referenced a CourageCampaign petition calling for a block on congressional pay until the shutdown is over.  As of Sunday morning, that petition had 385,098 signatures (including this author's).

Federal Reserve employees are also getting paid.  That's because the Fed is really privately owned and NOT an independent branch of the U.S. government - as is assumed by most Americans.  Victor Sperandeo asks rhetorically: "Why are Fed releases still going out, while the BLS cancelled the release of its U.S. monthly employment numbers last Friday?"

Victor continues, "An excuse might be that the Fed is "self-funding"... Well, "self-funding" actually means that the government is not entitled to the Fed's gross revenue (almost all of it from interest on the fixed income securities it owns).  That's because of the 6% dividend the Fed pays to its stock holders "after expenses," - just like any private company!"

Implications of Debt Ceiling Hit and Potential U.S. Government Debt Default:

The U.S. financial situation could get a lot worse if Congress fails to raise the US borrowing limit by the time the debt ceiling is hit – on or around October 17th.  The U.S. might then default on its debt.   Treasury Secretary Jacob Lew said Congress needs to pass a debt-ceiling increase by Oct. 17th or the U.S. will be “dangerously low” on cash and risk defaulting on its payments.

“On the 17th, we run out of our ability to borrow, and Congress is playing with fire,” Lew said on CNN’s “State of the Union” on Sunday. “If they don’t extend the debt limit, we have a very, very short window of time before those scenarios start to be played out.”

Alternatively, the U.S. Treasury would be forced to balance the federal budget abruptly. This would require humongous spending cuts, which would total approximately 4% of national income.  Obviously that outcome is unacceptable, as it would likely plunge the U.S. and global economy into an immediate recession. 

It seems incredible that the U.S. debt has increased so rapidly- it was $771 billion in 1978 and is now approximately $16.9 trillion.  That means our debt has compounded at an 8.95% annual rate- much faster than debt plagued Japan, which compounded at a 6.74 % from January 1982 to June 2013 (according to Victor Sperandeo).

In any event, Congressional gridlock and political uncertainty makes it almost certain that the Fed will not "taper" its $85 per month purchases of government bonds and MBS's anytime this year or until we have a new Fed Chairman in February, 2014.  In the upside-down world of unconventional Fed monetary largesse, bad news for the economy is often good news for the markets.  Could that be the case now?

Market Impact:  Little to None?

And the beat goes on... Market participants assume the Fed won't taper and that politicians will pull back from the brink ("in the nick of time"), because of the dire consequences of a U.S. debt default.  

CNN Money's Annalyn Kurtz wrote: "investors seem less convinced that a default will occur this time around than they were during the last big debt ceiling scare in the summer of 2011. Back then, they held contracts that would have paid out about $5.6 billion in the event of a default, according to the Depository Trust and Clearing Corporation."

Evercore Partners Chairman Roger Altman told Bloomberg TV that he doesn’t think there’s "any chance the US is going to default in any real sense of that term."  He also said there won't be even a "passing impact" on the U.S. economy or financial markets.  Mr. Altman expects 3% GDP growth in 2014.  He said that in previous incidents of Congressional debt ceiling brinksmanship, "Any dips in the equity markets have been promptly been made up on the other side."

“The conventional view, based on game theory, is that you don’t want to sell only to have to buy back later at higher prices,” Bill McQuaker, head of multi asset at Henderson Global Investors told the Financial Times. “There is a degree of sense in that – but it is not hard-wired into the system,” he added.

Stephen King, HSBC’s chief economist, tweeted from Washington, DC: “All sorts of game theory stuff is going on in DC . . . Time to brush off theories of mutually assured destruction . . .”


Many strategists believe a sharp financial market sell-off and the threat of significant disruption to the real economy may be needed before politicians are forced into a deal.  President Obama has warned that Wall Street should be worried. “When you have a situation in which a faction is willing to default on US obligations, and then we are in trouble,” he recently told CNBC.


In its weekend editorial titled, Politicians should not be complacent about market calm, the Financial Times opined: "Politicians should not be complacent about this. Once pessimism snowballs in the market, stopping it is extremely difficult. The hope must be that sanity returns to Washington, just as it did in Rome, before investors make up their mind that it is not going to." 

In a companion FT article, Raph Atkins wrote:  "The risk is that rudimentary calculations prove wrong – and that negative scenarios are being underpriced."


Other Voices: John Williams and Victor Sperandeo...

We asked our good friend Victor Sperandeo to comment on several key issues John Williams covered in his Oct 4th Shadow Stats  letter to subscribers:

1. More Tap Dancing on a Land Mine. The Administration Pulls Out a Couple of Hammers

Victor wrote in an email: "What John Williams has been stressing since the first QE was that this "land mine threat" was used to save the banking system - not cause above trend economic growth. The key phrase is the last line. The system will eventually blow up, as if you dance on a mine long enough, so will YOU!

The comment on "The Administration Pulls out a Couple Hammers" -was a reference to President Obama saying “the financial markets should be concerned about the shutdown/ debt crises." Related is the U.S. Treasury stating, "we are facing Armageddon if we default on treasury debt."  That's impossible, as taxes cover 6.5 times the annual interest due and the Fed has bought over 110% of the US debt issued this year....."

2.  Message to the Global Markets: Long-Range Solvency Issues of the United States Will Not Be Addressed

Curmudgeon asked: Does that mean the U.S. is headed for a true debt default/ perhaps from a "higher diving board" as Marc Faber said a couple of weeks ago?

Sperandeo:  "Debt default is impossible for the U.S.  A country with a printing press will use it to prevent sovereign bankruptcy. The one small time we let an investment bank fail (i.e. Lehman Brothers) we saw a worldwide decline of monstrous proportions. The US has saved banks, countries, and even hedge funds, and it didn't really mean to let Lehman Bros fail -if it knew the consequences. It will never happen again."

"In a 1884 decision ("Juilliard v. Greenman", 110 U.S. 421-1884), the U.S. Supreme Court rejected the claim that the issuance of greenbacks as legal tender in peacetime was not permissible. The Legal Tender Acts of 1862 and 1863 were upheld.  In an 8–1 decision, resting largely on prior court cases, 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."    Therefore, the law states the U.S. government (i.e. Treasury Dept. - not the Fed) can print money to pay debts-both private and public.  This makes U.S. debt default and bankruptcy virtually impossible in the U.S."


3.  Monthly M3 Suggests Deepening Systemic-Liquidity Distress; Annual Growth in Monetary Base Rising at Fastest Pace Since 2008 Crisis.

Graph of St. Louis Adjusted Monetary Base

Sperandeo:  "The Monetary Base is growing exponentially, but the Fed is "pushing on a string."  The huge growth in the Monetary base (high powered money) hasn't had a noticeable effect on the economy or price inflation, because the new money created by the Fed is being hoarded by Americans, while companies have not increased spending on new plant and equipment or hiring full time employees. Consider this Yahoo News article by Bernard Condon as supporting evidence: "Families Hoard Cash 5 Years After Crisis"   


While the (St Louis Fed published) Monetary Base is exploding at a 33% annual rate, M3 is only growing at a 4% year-over-year rate since January 2012, according to Shadow Stats estimates.

Mr. Williams wrote to his Shadow Stats subscribers:  "Nothing is normal: not the economy, not the financial system, not the financial markets, and not the political system. The financial system still remains in the throes and aftershocks of the 2008 panic and near - systemic collapse, and from the ongoing responses to the same by the Federal Reserve and federal government .Further panic is possible and HYPERINFLATION REMAINS INEVITABLE. "   (Emphasis added by Victor)"

Closing Comment:

Sperandeo sums up:  "A default will NOT happen as the taxes collected far outnumber the interest paid by the U.S. government.  The Fed will roll over the principal." 

"The important questions now are:

1.  Will the House of Representatives approve a reduction in spending bill to go along with a raising of the debt ceiling?

2.  Would the Senate approve it?  

3.  Would Obama accept such a "clean spending bill?" 


Sperandeo continues: "I think Obama would have to accept such a bill, which would avoid or at least postpone a debt default.  However, he would not be at all pleased with lower government spending, which would cause even slower GDP growth.  Spending cannot be the same as now in my view..."

About Victor Sperandeo:

"The Man of All Markets" (Barron's-May 2, 1983) is now and has always been much more than a "trader" of stocks, options and commodity futures contracts.  Mr. Sperandeo is a historian, economist and financial genius who has re-invented himself and the companies he's owned (since 1979) to profit in the ever changing and arcane world of markets, economies and government policies/procedures. 

As President and CEO of Alpha Financial Technologies LLC, Sperandeo overseas the firm's research and development platform, which is used to create innovative solutions for different futures markets, risk parameters and other factors.

More important than any of the above, Victor is a sincere, committed, generous and gracious individual thinker, who takes great pride in being with his tight knit family in Dallas, TX.  The CURMUDGEON considers himself to be extremely fortunate to have such a good friend!


Till next time.....................


The Curmudgeon

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.