This week I will indulge in some of the most popular gimmicks being proposed to work around the debt ceiling, which supposedly will be reached if Congress does not act by October 17th. These proposals vary in likelihood of success and seriousness. Here are the top 6:
1. Priority of payments.
What this means is that the government — unable to raise more debt — would continue to service the debt using tax revenues and paying interest on bonds first before other payments such as social security, military or other government pay, etc. Imagine a situation where one has a job and savings, but is suddenly and unfortunately laid off. The individual would make payments on debt out of his or her savings and perhaps sacrifice other things (such as leisure activity) in order to continue to remain current on the debt.
Moody’s, a credit rating agency owned partially by Warren Buffett’s Berkshire Hathaway, has suggested that the Treasury could utilize this method of payments so the government won’t default on October 17 if Congress cannot come to a deal to at least hike the debt ceiling.
I find it interesting that Moody’s is out there soothing investors about government debt, but it’s not surprising at all. S&P claims that it was sued by the United States over the subprime crisis in retaliation for downgrading its credit in 2011. Moreover, independent credit rating agency Egan Jones was sued and agreed to a ban on rating government debt in exchange for the government dropping its suit.
In other words, it’s dangerous to tell the reality of the problems with U.S. government debt.
There are at least two problems with the priority of payments scenario. First, we are to assume that the Treasury actually will prioritize payments. While one would hope that the Treasury does so, isn’t it possible that — like Obamacare’s employer mandate — the administration may decide not to prioritize payments? Unfortunately, the administration has been seen as willing to attempt to inflict as much pain as possible over the sequester cuts and the partial government shutdown theater. If this pattern continued with respect to government debt, the consequences would be dire.
Second, as brought up by Zerohedge, even if payments were prioritized the government still has a lot of debt which needs to be “rolled over,” because it matures by the end of November. When debt matures, the principal must be paid back unless the debt is “rolled over” into a new loan. Since the government cannot issue new debt, the maturing debt cannot be rolled over. The government not being able to roll over this maturing debt into new debt would be a big problem.
2. The 14th Amendment Solution: declare the debt ceiling unconstitutional.
There are many problems with this supposed “trump card.” The 14th Amendment, in relevant part, states as follows (emphasis added):
The validity of the public debt of the United States, authorized by law, including debts incurred for payment of pensions and bounties for services in suppressing insurrection or rebellion, shall not be questioned. But neither the United States nor any State shall assume or pay any debt or obligation incurred in aid of insurrection or rebellion against the United States, or any claim for the loss or emancipation of any slave; but all such debts, obligations and claims shall be held illegal and void.
In order for this to “work,” it requires a literal interpretation of the first sentence of 14th Amendment — while ignoring the context and the remainder of the Amendment.
The problem, of course, is the context. This part of the 14th Amendment is dealing with Civil War debts incurred by the Union, as opposed to debts incurred by the Confederate states. If my early American history is correct, there was a worry after the Revolutionary War that the government would not honor the debts incurred by the former colonies during the conflict. Secretary of the Treasury Alexander Hamilton ensured that such debts would be paid in full.
The Republican-controlled Congress which passed the 14th Amendment wanted to ensure that the debts incurred by the Democrats in Confederate States would not be honored. If you bet on the wrong side of the Civil War — you lost.
Fast-forward to today: I think that a federal court would punt on this question, either calling it a “non-justiciable political question” (meaning something that needs to be figured out by Congress and the Executive), or rule that the 14th Amendment does not invalidate the debt ceiling. Indeed, the “validity of the public debt of the United States, authorized by law shall not be questioned.” Any debt beyond the debt ceiling, ipso facto, is not authorized by law.
Besides, should the administration go down this path, it would involve briefs, arguments, appeals, and more arguments. That takes time — even on an expedited track. What happens to the markets while the academics debate?
3. The Fed cancels debt which it holds.
This idea goes back at least to the 2011 debt crisis. It was promoted by Ron Paul and currently Alan Grayson. The idea is that since the Federal Reserve holds federal government debt, we “owe it to ourselves” and we can therefore cancel the debt since (nearly) all payments made on it are refunded to the Treasury at the end of the Fed’s fiscal year.
In his op-ed, Grayson admits that there may be problems with cancelling Federal Reserve-held debt, but any consequences would be much easier to deal with than a default. That’s likely true. The big concern with I have is the precedent it sets. The cancellation of debt could spark worries by other holders of government debt that one day the U.S. will cancel the debt which they hold. That could start a panic, which would cause the selling of bonds and likely tank the broader financial and currency markets. It also dispenses with the illusion that Quantitative Easing is anything but “money-printing.”
4. Print debt-free “United States Notes.”
Another “Hail Mary” is to have the Treasury issue “United States Notes,” or Legal Tender notes. Under the law the Treasury is permitted to issue a certain number of United States Notes — which are simply another form of currency backed by the full faith and credit of the United States, but not issued pursuant to any debt obligation. Since these notes are outside of the Federal Reserve Notes system, they don’t add to the debt and, therefore, are not included in the debt subject to the debt ceiling.
The problem? The law currently only permits $346,681,016 to be in circulation. Absent of any legal authority to increase this number, it’s difficult to see how the administration could circumvent the debt ceiling using United States Notes. That’s not even touching issues concerning inflation should there be no limit to what United States Notes are printed.
5. Issue the “Super High Coupon Bonds.” #ITSHCB
The gambit here is that the Treasury issues high coupon bonds which have a low face value (so as to not breach the debt ceiling), but generate more revenue because holders of the debt will pay more than face value to buy the security due to the higher interest rate.
The U.S. government takes in $277 billion in tax revenues each month, and spends $452 billion each month, for a monthly deficit of around $175 billion.
It also has, on average, call it $100 billion of Treasury notes coming due each month.
Instead of just rolling those Treasuries — paying them off at 100 cents on the dollar by issuing new Treasuries at 100 cents on the dollar — it should pay them off at 100 cents on the dollar by issuing new Treasuries at 275 cents on the dollar and using the extra money to pay its bills. The 10-year yield today is around 2.6 percent, so you could sell a 10-year with a 23 percent coupon for 275 cents on the dollar.
The 30-year is about 3.9 percent, so a 14 percent coupon should get you there. Etc. Math here.
The problem? It assumes institutions, governments, and individuals buy the debt at the higher interest rates without concern for the status of the debt ceiling. This is entirely possible. However, there may also be a Gresham’s Law issue here as well. Gresham’s Law is that “good money” is chased out of the system by “bad money” and, most recently, refers to the disappearance of silver coinage from circulation when the Treasury switched from silver to base metal coinage in 1965. Would the issuance of Super High Coupon Bonds cause investors to dump the lower coupon bonds? That’s certainly a concern.
6. Sacajawea to the rescue?
Finally, another amusing option would be to #MintTheCoins. Not a trillion-dollar coin, but to increase coinage in circulation of the current U.S. dollar coins. Since coins minted by the Treasury, like United States Notes, are direct obligations on the Treasury and are not debt-backed — the debt would not increase.
The obvious problem is the time and cumbersome nature of minting billions of dollar coins. Since the Mint makes about $20 billion in coins a year, that would cover government expenditures for about two days. Oh well.
Bottom line — gimmicks are likely not going to work. We need the government to pass legislation that addresses fiscal concerns adequately and gets us on the path of fiscal sanity. We should not have to be passing debt ceiling increases every few months. As Pocket Full of Liberty’s own Amy Otto opined on the most recent podcast, the administration should put forth a plan explaining how much of a debt ceiling increase they need for the rest of President Obama’s second term so the House and Senate can work against that backdrop and focus on the root cause of our unsustainable debt: overspending.
As always, free markets are better markets.
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This week, the financial discourse will be dominated by the debt ceiling and government shutdown debate. We also can look forward to earnings reports from numerous companies including Intel and Coca-Cola, among many others.
Have a great week!