Recently, a big elephant has entered the room carrying several issues from Washington DC. We’ll endeavor to break it down a little bit here – but keep the essence as financially-oriented as possible.
There are four big issues in Washington currently being worked through. Each one of these would be, in and of itself, a major hurdle to overcome – and as of now, our political and financial leadership must deal with all four of them. Let’s start with the “easy” one that’s already been resolved:
The budget. The government cannot operate without a budget and its fiscal year-end was September 30th. Biden signed the government funding bill hours before midnight deadline to avert shutdown. The measure keeps things running through December 22, 2021. Keep in mind that, a government shutdown is not a default on debt. This is the government closing, and there is a big difference. Remember what happened from December 22, 2018, through January 25, 2019? Parks shut down, government-run offices closed, etc. This is a far cry from a default of the government’s ability to pay interest on loans they’ve already assumed. To keep the government operating, congress can pass what are called continuing resolutions or measures that continue operations. Fortunately, they usually get bipartisan support, as did this budget decision recently, and it passed, putting a band-aid on this matter temporarily. We (or our political leadership) still have three other issues, and this is where politics comes in more heavily – portending financial market volatility.
The infrastructure bill. In total, the deal includes around $550 billion in new federal investments in America's infrastructure over five years. This issue must be approved by the House before it can head to President Biden's desk. The problem is that Democratic House progressives don't want to vote on this bipartisan infrastructure legislation before also voting to pass a separate Build Back Better Act (BBB). The BBB is a $3.5 trillion spending bill that would remake a lot of the country's social safety net system -- and also likely raise taxes on “the wealthy” and corporations. Clearly a bit of a catch-22 here.
The $3.5 trillion spending bill. Basically, this provides funds over 10 years to improve or create social safety net type programs surrounding healthcare, family support, education, and climate programs. As mentioned earlier, passage of this bill is tied into the infrastructure bill above and has tie-ins to the debt ceiling limit issue below.
The debt ceiling limit. This part is generating some volatility in the stock and bond markets lately. Along with the problems in China, interest rate and inflation volatility tied to global supply-chain problems, ongoing virus issues, and a historic run of a bull market, one would conclude that the current market was ripe for a pullback and volatility. But back to the debt ceiling. You likely know that our debt has risen dramatically over the last few years. This fact alone makes the debt ceiling problematic politically. Regarding the current matter (politically), the Republicans are sitting this whole thing out. The Republicans argument is basically this: you (the Democrats) are the majority of The House, The Senate, and you have the presidency. You Democrats have the ability to pass this whole thing without a single Republican vote. Concurrently, the Democrats are not negotiating with the Republicans to modify the bill in order to get some Republican votes. Democrats are negotiating among themselves which presents a whole new problem. So, the Republicans’ position is essentially this: Go ahead - if you're not going to give us anything, you can pass the whole thing by yourself.
The problem is created when it comes to the debt ceiling. This is an extraordinarily politically unpopular issue. No party wants to do that in a bipartisan way, because then they all own that decision. Each party, be it Democrat or Republican, want political cover in having it be partisan. But, as just stated earlier, the Democrats don't want to give the Republicans anything on which to vote with them for the infrastructure and spending bills, which creates the sticking point in essence. That is, the debt ceiling limit can’t be resolved until the Democrats decide what they want to do, Progressive and Moderate Democrats can’t agree on what’s passable with the big spending bills, and Republicans are sitting out. Following weeks of partisan fighting, the Senate finally approved a short-term fix which the House of Representatives passed on Tuesday. By Thursday, President Biden signed the legislation which temporarily raised the government's borrowing limit to $28.9 trillion, pushing off the deadline for debt default only until December. The $480 billion increase in the borrowing limit is expected to be exhausted by December 3rd.
An additional conundrum for the next debt ceiling vote:
After approving the temporary fix, Senate Republican leader Mitch McConnell wrote in a letter to President Biden that he would not help Democrats again in raising the debt limit. With Republicans intent on blocking the next vote, the Democrats would need a filibuster proof outcome of 60 votes – and it seems clear they are not going to get that. So, they're attaching it to the spending bills, and the whole deal will likely be done via Reconciliation, where Democrats don’t need any Republican votes at all. That means that you can bypass filibusters and you only need 50 votes, which means every Democrat needs to be a “yes” vote, and then Kamala Harris breaks the tie (which she most certainly would), and there you have it - $4 trillion dollars in new spending.
Now, Democrats have got a majority of five votes in The House, but here's the rub: You've got Kyrsten Sinema (Democrat-Arizona), Joe Manchin (Democrat-West Virginia) and other Democratic moderates saying that this $3.5 trillion dollar bill and the infrastructure bill is way too much spending. Joe Manchin came out and called it “the height of fiscal irresponsibility.” He's made it very clear he's not going to vote for this thing unless it’s pared back quite a bit. At the same time, the Democratic progressives have said basically; If we don't get both bills passed together with all the spending, then we're not going to vote for it either. So, again, there's the impasse. It is Democrat among Democrat fighting…and hanging in the middle of the fight is the debt ceiling bill. Hopefully that gives you an idea of where we are.
So, what happens if the US government experiences a default in early December?
It’s not good. The daily cash balances at The Treasury as of last week are down to $46.5 billion. With the temporary debt ceiling increase, this number should hit zero around December 3rd. When it hits zero, they run out of money to fund the government. The government will still be open because of a continuing resolution, but they’ll have no money to fund it. The result is, we default on payments.
If the government can’t pay, in essence, the value of a dollar can go from 100 cents down to 99 cents. This is called “breaking the buck”. If we default and a dollar is no longer worth 100 cents, all hell breaks loose with it, because in the United States, and all around the world, the US Dollar is viewed as the safest possible instrument there is. A bank, money market fund, or anyone else tries never, ever to break the buck. When it does, we can look at the Global Financial Crisis as an example of the financial disaster that ensues. While this may be a shorter-term disaster than what happened in 2008, it will hurt the markets most surely for a while.
Even now, this remains a low probability event, as almost any politician knows that it’s hard to get re-elected during times of financial insecurity, and this is a purely political decision.
