Government Shutdown/Debt Limit - Issues and Timelines for Investors

[Palpatine]

My question is whether Jim Demint wants a default. There has been rhetoric wafting around the Tea Party for awhile now indicating an affirmative desire to engineer a default as a part of a strategy to permanently shrink the government. If he does, and if he starts whipping the conference through Cruz and the other like-minded Tea Party guys, Boehner and the other "moderates" are weak enough that they might just roll over like they always roll over.

That is an interesting idea that I have not yet considered. They want a default so that it forces the shrinking of government. If we are no longer the world reserve currency, that will dramatically reduce our ability to refinance our debt at such artificially low treasury rates. Rates rising to 5% would explode our interest payments and crowd out a lot of other discretionary spending.

At the end of the day, I don't think either party wants a default. A few people might be less concerned than others (Demint, Bachmann).

But it is also fairly obvious that reforms to entitlements have to come. Everyone agrees on that issue. In the absence of a deadline on "must pass" legislation, I don't see any progress being made on any spending or entitlements. There is no pressure to negotiate without a deadline and horrible consequences.

 

[CapitalistOppressor]

That is an interesting idea that I have not yet considered. They want a default so that it forces the shrinking of government. If we are no longer the world reserve currency, that will dramatically reduce our ability to refinance our debt at such artificially low treasury rates. Rates rising to 5% would explode our interest payments and crowd out a lot of other discretionary spending.

At the end of the day, I don't think either party wants a default. A few people might be less concerned than others (Demint, Bachmann).

But it is also fairly obvious that reforms to entitlements have to come. Everyone agrees on that issue. In the absence of a deadline on "must pass" legislation, I don't see any progress being made on any spending or entitlements. There is no pressure to negotiate without a deadline and horrible consequences.

Note: Doom and Gloom Post Incoming.

One bonus result for the Tea Party of pursuing a default would be the possibility that Obama would step in after a default to assert the constitutional power to sell Treasuries. Like many others, I think he would have a decent legal footing to do so, as well as an obligation to act in order to mitigate the worst effects of a default.

However, I also recognize that his "legal authority" is hardly cut and dried, and has never been litigated. Ultimately that decision rests with the Supreme Court.

Given that, the bank shot bonus that the Tea Party gets is a "legitimate" reason to institute impeachment proceedings against Obama. That of course will fail in the Democratic Senate, but that wouldn't be the point.

If some hypothetical Tea Party types were playing n-dimensional chess with a potential default scenario, an Obama impeachment could be quite attractive.

First, there is little doubt that a unilateral move by Obama to sell Treasuries would be legally controversial. This move would be occurring in the context of market chaos. A quick move by the House of Representatives to impeach Obama over the issue could help fix the "blame" over the unfolding chaos on Obama.

Even on the "merits", Republicans could argue that the unapproved sale of Treasuries was inflaming market uncertainty and making what should have been a minor issue into a major one, and this was occurring because Obama was breaking the law.

Second, this debate would also serve as a media distraction from the actual damage being caused by a default. There is only so much media bandwidth to go around, and much of that shift would come at the expense of stories that might otherwise be leveling blame on House Republicans.

Third, the rank and file in the Tea Party (and affiliated media) have been agitating for an Obama impeachment since 2010 (or November of 2008, depending on how you measure it). So being able to engineer this would allow Tea Party elites to serve up a heaping helping of red meat for their base.

Fourth, political movements that exist closer to the edge of the political spectrum do a lot better in economically chaotic conditions, and those same conditions favor parties that are out of power. Both factors could well play to the benefit of the Tea Party, and would do so at a time when they are muddying the waters as far as blame is concerned, while also moving forward into 2014 with an extremely energized base.

Edit:

Fifth, to the extent that this strategy works, the failure of the impeachment in the Democratic Senate might help the Tea Party make gains in the Senate in 2014.

 

[Palpatine]

FYI... we won't default even under the worst case scenario. Monthly interest payments amount to about $20 billion to $30 billion. Monthly tax receipts are over $200 billion.
Worst case scenario they will pay the interest on the debt.

Of course, 25% to 30% (the federal budget deficit) of the rest of the government won't get funded for a few weeks while they resolve their differences.

I expect all of that debate would end right about the time that the next Social Security checks are due to go out. I don't see any of this going beyond whatever that date is.

 

[FluxCap]

FYI... we won't default even under the worst case scenario. Monthly interest payments amount to about $20 billion to $30 billion. Monthly tax receipts are over $200 billion.
Worst case scenario they will pay the interest on the debt.

Of course, 25% to 30% (the federal budget deficit) of the rest of the government won't get funded for a few weeks while they resolve their differences.

I expect all of that debate would end right about the time that the next Social Security checks are due to go out. I don't see any of this going beyond whatever that date is.

Huh? Are you somehow assuming that a default would not raise interest rates, and, concordantly, the interest on the National Debt? Not sure I understand...

 

[dmunjal]

CapOp, I thoroughly respect your intelligent analysis and commitment to finding answers here, but I'm just going to say it again: you are drastically underestimating the consequences of debt default. Here is the progression I see, simplified:

1) Default
2) Dow halved, markets shut indefinitely
3) Interest rates move to 40%, borrowing becomes impossible -- corporations, municipalities, families and individuals declare mass bankruptcy
4) US Dollar becomes worth a dime or less, overnight
5) Interstate commerce shuts down, prices for basic necessities become stratospheric, food shortages as nothing on shelves
6) Money worthless
7) Rioting begins, National Guard deployments begin
8) Rioting intensifies to organized rebellion, martial law declared
9) Food rationing commences, internet access shut down or disrupted consistently, power shortages, mass refugees flee from country to cities
10) Second civil war begins

This is what the Tea Party wants, brother. Because they actually think that step 11) here is "Tea Party wins, create a new country founded on really cool white people power stuff with almost no regulations/laws/taxes at all, and no government except that which we install." Obviously this isn't true, because step 11) actually is "Tea Party thinks it can win, bands together 200,000 strong militia, marches on Washington. Three or four Apache gunships kill every last mother****er with a gun, war ends, Tea Party captured, jailed and abolished. A decade of US prosperity ruined. China jumps for joy and decides whether or not to invade or just make us their complete and total bitch for life.

That is the consequence of debt default. This is what John Boehner meant when he said "This isn't some damn game."

So debating the finer points of what could "legally" happen is pointless. There would be no more rule of law, there would be abject anarchy. And John Boehner and I may differ on just about every last policy consideration before the Congress, but we sure as hell don't differ on our desire to live in a country that isn't in the midst of a Civil War, where all our money counts for nothing, and no one is safe in their homes.

In the end, there will be no default, but there most certainly will be a spirited discussion of just how badly the Republicans will lose in 2014 and again in 2016, no matter how ****** Obama and the Dems are at governing.

What does this mean for TSLA? It means invest with extreme caution in the next few weeks, and hopefully resume normal life after that.

Washington sucks, but it's all we've got.

That's a bit sensationalist. Remember in 2011, just the threat of breaching the debt ceiling caused investors to buy more US dollars and bonds which as a safe haven driving interest rates down, not up. Yes, the stock market dropped 16% but quickly recovered.

It might turn out to be the buying opportunity of a lifetime. Just like in 2011.

My belief is the real default will not come by our own hand. Not even the Tea Party. The default will come when our creditors finally say no more and interest rates finally rise. That is your doomsday scenario and we are far from that right now.

 

[FluxCap]

That's a bit sensationalist. Remember in 2011, just the threat of breaching the debt ceiling caused investors to buy more US dollars and bonds which as a safe haven driving interest rates down, not up. Yes, the stock market dropped 16% but quickly recovered.

It might turn out to be the buying opportunity of a lifetime. Just like in 2011.

My belief is the real default will not come by our own hand. Not even the Tea Party. The default will come when our creditors finally say no more and interest rates finally rise. That is your doomsday scenario and we are far from that right now.

In what world does an actual (not threatened, but actual) debt default not raise interest rates?

 

[Palpatine]

Huh? Are you somehow assuming that a default would not raise interest rates, and, concordantly, the interest on the National Debt? Not sure I understand...

I am saying that there would not even be a default.
If they really do go beyond October 17th, then the Treasury department is going to have no other choice but to make interest payments on the debt. Other areas of the government will go unfunded.

Monthly payments to service the interest on the debt are about $20 billion to $30 billion.
Monthly income from tax receipts is over $200 billion.

Bottom line = Treasury Department can pay the interest on the debt even if Congress doesn't raise the debt limit.
But other areas of the government (Social Security, Medicare, Medicaid, Defense) will not have enough money to fund everything.

My prediction if it really gets to that point: They reach a compromise right before Social Security checks are due to go out, whatever date that is after October 17th.

- - - Updated - - -

My belief is the real default will not come by our own hand. Not even the Tea Party. The default will come when our creditors finally say no more and interest rates finally rise. That is your doomsday scenario and we are far from that right now.

I agree. At some point bond investors are going to get really nervous about of debt being at the same levels of Italy or Greece. We are currently at 100% of debt to GDP. Italy is at over 120% of debt to GDP. We are withing about 5 years of being at that debt level with current projected deficits. So it will get very dicey for the next president in the absence of any reforms. The bond markets could just start avoiding our debt and cut us off, just like Portugal, Ireland and Greece. We are not that far from such debt levels.

 

[dmunjal]

In what world does an actual (not threatened, but actual) debt default not raise interest rates?

As others have mentioned, mathematically, there can never be an actual default on the debt (the interest payments on it).

Edit: I should add "at current interest rates." If interest rates shot up to double digits, we might actually default.

 

[FluxCap]

Monthly payments to service the interest on the debt are about $20 billion to $30 billion.
Monthly income from tax receipts is over $200 billion.

Again, you are somehow assuming both interest rates and revenues remain constant in a world in which the United States T-Bills approach worthlessness. I don't agree this is possible. A default would jack interest through the roof, and annihilate tax receipts as the economy contracts even further due to complete lack of government spending followed by absolute devastation of corporate spending. It's a chain-reaction trap that feeds on itself until the interest on the debt becomes unpayable with receipts even if we didn't spend a dime on anything but interest...and then what?

Edit: If you don't believe me or understand me, perhaps you should read this:
Catastrophic Consequences of a U.S. Default Explained | Breakout - Yahoo Finance

 

[dmunjal]

Again, you are somehow assuming both interest rates and revenues remain constant in a world in which the United States T-Bills approach worthlessness. I don't agree this is possible. A default would jack interest through the roof, and annihilate tax receipts as the economy contracts even further due to complete lack of government spending followed by absolute devastation of corporate spending. It's a chain-reaction trap that feeds on itself until the interest on the debt becomes unpayable with receipts even if we didn't spend a dime on anything but interest...and then what?

Let's say 2011 was a dry run for your scenario. You have to look at money flows. Everyone sold stocks because the economy was at risk. But that money went INTO bonds which lowered interest rates. Bond investors were never worried about their interest payments. That's the $17T bond market talking, not some stupid analyst on CNBC. Again, the Treasury takes in 10 times the amount that it costs to service the debt.

Your scenario would require interest rates to go up to 10% ($1.7T in interest payments) and revenues to drop by 40% (from $2.5T to 1.7T).

Even that wouldn't happen overnight as existing bonds would have to rollover.

 

[dmunjal]

Again, you are somehow assuming both interest rates and revenues remain constant in a world in which the United States T-Bills approach worthlessness. I don't agree this is possible. A default would jack interest through the roof, and annihilate tax receipts as the economy contracts even further due to complete lack of government spending followed by absolute devastation of corporate spending. It's a chain-reaction trap that feeds on itself until the interest on the debt becomes unpayable with receipts even if we didn't spend a dime on anything but interest...and then what?

Edit: If you don't believe me or understand me, perhaps you should read this:
Catastrophic Consequences of a U.S. Default Explained | Breakout - Yahoo Finance

I'll trust the actions of bond investors over some analyst on Yahoo. Again, watch the markets the next couple of weeks. The stock market will correct but the bond market is not worried.

If the debt ceiling doesn't get resolved for months, then the bond market will likely discount a depression scenario which could eventually lead to a panic. But as the stock market crashes after a few weeks, the Republicans will cave in. 2008 proved that.

I'm getting my cash pile ready to go bargain hunting. Including TSLA.

 

[FluxCap]

Let's say 2011 was a dry run for your scenario. You have to look at money flows. Everyone sold stocks because the economy was at risk. But that money went INTO bonds which lowered interest rates. Bond investors were never worried about their interest payments. That's the $17T bond market talking, not some stupid analyst on CNBC. Again, the Treasury takes in 10 times the amount that it costs to service the debt.

Your scenario would require interest rates to go up to 10% ($1.7T in interest payments) and revenues to drop by 40% (from $2.5T to 1.7T).

Even that wouldn't happen overnight as existing bonds would to rollover.

Interest rates spikes of over 10% are virtually guaranteed in a default scenario, as are 40% declines in revenue (minimum). They feed on each other...how can you all not see this? It's not the market's reaction to the possibility of a default I'm talking about, it's ACTUAL default. I fail to see the relevance of what the (healthy) bond markets did in 2011. It was most certainly not a "dry run" for this nightmare scenario.

If you think double-digit interest is an impossibility, I suggest you study history a bit further.

- - - Updated - - -

I'll trust the actions of bond investors over some analyst on Yahoo. Again, watch the markets the next couple of weeks. The stock market will correct but the bond market is not worried.

If the debt ceiling doesn't get resolved for months, then the bond market will likely discount a depression scenario which could eventually lead to a panic. But as the stock market crashes after a few weeks, the Republicans will cave in. 2008 proved that.

I'm getting my cash pile ready to go bargain hunting. Including TSLA.

I am saying that default is not going to happen because the consequences would essentially unmake modern capitalism, and that bargain-hunting is possible in the near-term as a result, but short-term investment positions should be played very carefully. So I think you agree?

 

[dmunjal]

Interest rates spikes of over 10% are virtually guaranteed in a default scenario, as are 40% declines in revenue (minimum). They feed on each other...how can you all not see this? It's not the market's reaction to the possibility of a default I'm talking about, it's ACTUAL default. I fail to see the relevance of what the (healthy) bond markets did in 2011. It was most certainly not a "dry run" for this nightmare scenario.

- - - Updated - - -



I am saying that default is not going to happen because the consequences would essentially unmake modern capitalism, and that bargain-hunting is possible in the near-term as a result, but short-term investment positions should be played very carefully. So I think you agree?

If there was any risk of your scenario happening in two weeks, the bond would be reacting now. It hasn't.

The stock market is reacting and that's why I'm looking to buy before the inevitable resolution.

We are not going to commit suicide. We might eventually be killed by our creditors though.

 

[FluxCap]

If there was any risk of your scenario happening in two weeks, the bond would be reacting now. It hasn't.

The stock market is reacting and that's why I'm looking to buy before the inevitable resolution.

We are not going to commit suicide. We might eventually be killed by our creditors though.

Right, so we agree then...?

 

[Palpatine]

If there was any risk of your scenario happening in two weeks, the bond would be reacting now. It hasn't.

The stock market is reacting and that's why I'm looking to buy before the inevitable resolution.

We are not going to commit suicide. We might eventually be killed by our creditors though.

Exactly. The bond market is not worried about getting their interest payments. A "default" is not even remotely possible when the government brings in over 10X more revenue than their interest payments.
I wonder if the nuts on TV spouting about "default" even really know what that means. They use the term so casually without even understanding it.

 

[FluxCap]

Exactly. The bond market is not worried about getting their interest payments. A "default" is not even remotely possible when the government brings in over 10X more revenue than their interest payments.
I wonder if the nuts on TV spouting about "default" even really know what that means. They use the term so casually without even understanding it.

Revenues in a contracting economy with no government spending don't just chug along merrily, and interest rates don't just remain zero. But regardless, you guys are speaking as if I was suggesting default was a probability, and I'm stating just the opposite -- failing to raise the debt ceiling WOULD create a likely default situation, but the markets haven't priced it in because IT'S NOT GOING TO HAPPEN.

You can't trade on doomsday scenarios, so no one does. Period.

 

[CapitalistOppressor]

Just a note. My personal view is that a default would be pretty effed up and depression level damage seems right to me.

That said, anyone who claims to have any idea of what will happen if the U.S. hits the debt limit is making an educated guess at best. Especially considering the unique status of the U.S. dollar and U.S. Treasuries in the modern, hyper-connected, global system, we literally have no basis of comparison that we can make with any existing historical precedent.

The title of one of my sections in the OP was "Is it Time to Buy a Gun?". The point was to convey the drastic levels of uncertainty inherent with the potential for a U.S. default (whether of Treasuries, or of other obligations).

However, I think that while we can't discount the most sensationalist possibilities, on the whole I don't put a lot of credence into the notion that a default will ultimately drive us into a Mad Max level dystopia. And even if there was a path through which a default might lead to such an extreme outcome, I don't see how it would be relevant to this discussion, especially to the extent that it gets us into a political food fight with each other.

A garden variety market panic is plenty able to rapidly stick a shiv into our portfolios, and our initial strategies to limit our exposure would largely be the same regardless of what your predicted outcome of a debt limit fight is.

 

[Palpatine]

I am saying something different. I am saying that even if there is no deal by October 17th, that is not a default.
It just means that there will be a lot of pissed off senior citizens looking for someone to blame next election. Because if those Social Security checks don't go out and if doctors start refusing medicare patients, then there will be hell to pay.
The bond markets will still get their money on time.

http://www.socialsecurity.gov/pubs/calendar2013.pdf

I think that chart indicates that the next big date for Social Security, after the Oct 17th "deadline", will be on October 23rd. That is when I think they will have to reach a deal otherwise senior citizens won't get paid on time.

 

[FluxCap]

Just a note. My personal view is that a default would be pretty effed up and depression level damage seems right to me.

That said, anyone who claims to have any idea of what will happen if the U.S. hits the debt limit is making an educated guess at best. Especially considering the unique status of the U.S. dollar and U.S. Treasuries in the modern, hyper-connected, global system, we literally have no basis of comparison that we can make with any existing historical precedent.

The title of one of my sections in the OP was "Is it Time to Buy a Gun?". The point was to convey the drastic levels of uncertainty inherent with the potential for a U.S. default (whether of Treasuries, or of other obligations).

However, I think that while we can't discount the most sensationalist possibilities, on the whole I don't put a lot of credence into the notion that a default will ultimately drive us into a Mad Max level dystopia. And even if there was a path through which a default might lead to such an extreme outcome, I don't see how it would be relevant to this discussion, especially to the extent that it gets us into a political food fight with each other.

A garden variety market panic is plenty able to rapidly stick a shiv into our portfolios, and our initial strategies to limit our exposure would largely be the same regardless of what your predicted outcome of a debt limit fight is.

I agree with mostly everything CapOp said here, with the possible exception of historical precedent -- I don't think studying the history of markets is relevant here, but I do think studying human behavior in crises, and the history of the rise and fall of civilizations over time is quite relevant. Fortunately, I'm confident that many of our elected leaders on both sides of the aisle recognize a point of no return when they see it, and are smart enough to steer clear.

The marginalization of the Tea Party and a heck of a buying opportunity are about the best things I could see coming out of this farce of human frailty and hubris.

Meanwhile, I'm looking forward to driving my Tesla.

 

[Norse]

Any update? Market does not look good. And its having an effect on the rest of the world aswell.