February 16, 2023 • 50 mins
The US is in the middle of another debt ceiling fight. The expectation is that it will get lifted before we hit the so called "drop dead" date — but what happens if Congress does not authorize more debt financing? What are the options for the government? Does this automatically lead to default? And if the US does default on its debt, what does that mean for the financial system and the real economy? On this episode of the Odd Lots podcast, we speak with George Pearkes, macro strategist at Bespoke Investment Group, about how the debt limit actually works, and we attempt to get an understanding of what to expect if we reach this uncharted territory.
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Episode Transcript
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Speaker 1 (00:10):
Hello, and welcome to another episode of the ad Thoughts Podcast.
I'm Tracy Alloway and Joe uh debt ceiling. Oh, I'm
so excited we're doing a trillion dollar coin episode. I
knew you were going to say that and to annoy me. Yes,
this is not an episode on the trillion dollar coin.
(00:30):
If you are interested in that particular piece of um
finance thought experiment, you can check out our previous episode
on the topic. I think it was over an hour long,
all about the trillion dollar coin. Yeah, okay, check out
that episode if you want to talk about the trillion
dollar coin. But today we're going to be discussing something
(00:51):
slightly different. We are going to be talking about what
exactly happens if the US actually does default, right, because
if there's like just a lot of uncertainty about this
question of like okay, like what happens if they don't
raise the dead ceiling? And what are the constraints, what
are the various things that could happen, Like how bad
(01:11):
would it be if we actually, like didn't pay the debt?
Does the White House have ability to pay some debt
but not others? Like it's pretty uncertain, Like it seems
bad right, like it is lame and defaulting was bad.
Russia default was bad, and Russia is like this like tiny?
You know how big was russia debt nothing? So like
(01:34):
it is a moving feast of uncertainty, like a twirling
whirlwind of chaos and uncertainty and open questions over exactly
what happens. And there are all these moving parts. I
think we really need to sit down and discuss them
and kind of talk about it in an almost sequential way,
like this is what happens if this happens, and then
(01:54):
that happens. So we really do have the perfect guest
for this. We're going to be speaking with Joe Perks
and add thoughts favorite of course, he is also global
macro strategist over at Bespoke Investment Groups. So George, thank
you so much for coming back on all thoughts. Hey all,
thanks for having me. Let's start with the basics, since
we're talking about this as a sort of primer episode
(02:17):
on the debt ceiling and the debt limit. When we
talk about limits on US debt, what do we mean exactly?
So the US is really unique in a very frustrating
way in that not only do we have restraints on
spending in terms of Congress authorizing and the President signing
(02:37):
into law bills that create government spending um and then
appropriations processes after that, you know, throughout the year, we
also have this break on the total amount of debt
that can be issued. So Congress can at the same
time instruct the government bureaucracies to go out and spend money,
but at the same time say, oh, well, you can't
(02:58):
actually issue debt to you that spending we've told you
to do. And oh, by the way, you can't collect
anymore in taxes because we also control that and we've
told you the amount you can collect in taxes. So
it's this contradiction in terms of instructions to the executive
branch and to various federal government bureaucracies from Congress and
from the President, and it's it's a thing that's been
around in US politics for a long time. But you know,
(03:21):
I think the most important thing to understand about it
is that it's just it's nonsensical. It doesn't make sense
for there to be this extra restraint on top of
the existing safeguards against you know, in a representative democracy
where people are elected and then they authorize the spending
on behalf of the population. We also have this thing
where there's a debt, there's a debt limit that that
(03:42):
serves as sort of a secondary veto point on government spending.
Defenders of the debt ceiling law would say, look, kind
of that's true, but it is good to have this
debate every couple of years about our level of indebtedness.
This can be used as a break of sorts for
or constraining spending. In the Dead Ceiling fight, there really
(04:04):
was cuts and the cuts to the growth of federal spending.
You know, you're saying, like, okay, like this is like
the sort of like maddening law makes no sense. Does
the dead ceiling have a history of like being used
to sort of regroup and retrain our thoughts about how
much we're spending. The short answer is no. And I
think that the more consistent way to think about it
(04:24):
historically is that it's used by one factionum or another
in US politics against whoever happens to sort of be
the party in control. So you know, this is this
is a bi partisan thing. It's used both ways. Both
parties have declined to get rid of the dead ceiling
on a permanent basis when they've been empowered. So I
don't mean to say that this is a red versus
blue you know, one side an abuser of this versus
(04:47):
the other. But what it does is it just it
creates a veto point and allows the legislative minority to
extract what it wants from or some of what it
wants from the legislative majority. Now that's not necessarily the
end of the w old, but there are a couple
of things to think about here. First, the U S
system of government is already full of veto points, right,
whether it's process of buils through committees, process of builds
(05:08):
through the House, process of builds through the Senate, judicial
checks on all that, the executive branch, the high requirement
in the Senate to sign things in the law. There
are some exceptions, but basically you need a supermajority in
the Senate to get things signed in the law. So
there's just we have a replete number of veto points,
adding you know, just one more. The benefits are pretty
negligible even if you agree that that. You know, controlling
(05:31):
the debts size is a super important public policy goal.
I don't happen to agree with that, but let's take
that as given. Even then, there are costs associated with
this that that are very real. And the cost is
the credibility of the U. S is ability to pay
its debts on time in full. And you know, there
are real questions about the United States Treasuries ability to
settle out coupon and interest payments on debt, let alone,
(05:53):
payments to Social Security recipients, payments to government contractors, government employeescetera, etcetera.
This year because of this death ceiling being present. And
again I think it's really important to emphasize debt ceiling
being present. Even though those payments, all those payments that
are set to go out, all the spending, all the
payments that are set to come into the treasury and
formed taxes, all of that has already been approved by Congress.
(06:13):
The debt ceiling is a secondary approval's process that has
nothing to do with keeping a lid on on spending
in a direct sense. So, George, you you just set
out the stakes kind of perfectly there. But talk to us.
You also mentioned the treasury. Talk to us about extraordinary measures,
because the U. S. Treasury has already said that it's
(06:34):
started to take these extraordinary measures in order to meet
its obligations because we have in fact already exceeded that
thirty one point four trillion dollar or whatever it is
borrowing limit. What are the extraordinary measures and how do
they actually play out here? So there are a variety
of things that go into the extraordinary measures behind the scenes.
(06:55):
I mean, the simplest way to think about it is
changing timing of payments and sort of where there's flexibility
to defer payments or to pay them, you know, without
issuing debts, to wait for new payments to new tax
payments to come in before sending out existing payments. That's
one way to think about it. The most important thing, though,
is spending down the balance that's recorded in the Treasury
(07:18):
General account at the Federal Reserve. So the Federal Reserve
is the United States Treasuries fiscal agent, which basically means
that that payments are being made via the feed. So
if you're if you're the Treasury, you don't have a
checking account at a private bank. You have a checking
account at the Fed. There are ways in which the
government is nothing like household, but in terms of access
(07:41):
to a checking account, that is one way the government
is like a household. There is a account at the
Fed again called the Treasury General Account that is essentially
a cash balance, a balance available for payments that is
used to settle payments owed by the Treasury to other
individuals or entities throughout the economy. And what the Treasury
has been able to do since whether they're able to
(08:03):
do it beforehand, but what if they've done as a
matter of course since, is build up this this Treasure
General Account in the period leading up to debt ceiling
limits being reached, because that allows for flexibility over the
subsequent months. Basically, if you know that you're going to
be without a paycheck for a couple of months, you
save some cash away and your checking account. You're not
(08:24):
going to buy a long term investment with it because
you know you'll need it, but you'll have a little
balance in your checking account, and then when your paycheck
doesn't come through, you can still pay your rent for
a couple of months. You can't do it indefinitely, but
you have this sort of cushion there, and that's sort
of what the charge of General Account spend down is
and that's the core of extraordinary measures that that allows
the Treasury to continue to make all the payments it's
mandated to buy law, you know, whether that's UH payments
(08:45):
to contractors, payments to employees, payments to beneficiaries, whatever, payments
to holders of the national debt. All those can continue
to go out the door as normal, in part because
there's this cash balance at the t g A that's
being spent down. Okay, we have these sort of like
they're called extraordinary measures, but they're not like that weird.
They're like little like they're more like, you know, short
(09:06):
term cash management techniques that allow the government to make
its obligations for a few extra months. Let's talk about like, okay,
when those run out, what happens? Like where where do
things stand? You know? People talk, I don't know, like
what is your estimate for when like the sort of
real debt limit is right when we no longer have
(09:26):
these sort of drop dead Yeah, so the X date
the drop dead date? Talk about like what happens as
we get closer to that. I so, I personally don't
think my estimate is any better than what we've heard
from charity or from the Secretary Treasury yelling, she says
June five, this sort of her best estimate, but one,
It's important to understand that she described it as having
considerable uncertainty. So, for instance, if we have a really
(09:49):
really strong tax collection season or really really weak tax
collection season over the next three months, that's going to
have big implications for the timing here, right, just because
a huge percentage of cash flows in and out of
the Treasury take lace over over tax season. So you know,
there's just all sorts of uncertainties. Also, private sector of
visibility is is not great into all the timing of
payments in there and their size. So I'll just make
(10:09):
that you know, I think sometime in May June is
probably the right way to think about it. Um, late mate,
early June, we'll we'll hit this drop dead day where
essentially there are more payments being requested from the Treasury
than there is cash balance plus payments being made to
the Treasury. At that point, I think it's important to
stress that we don't actually know what's going to happen.
Nobody knows. There may be Treasury bureaucrats somewhere that know, um,
(10:32):
but for all intents and purposes, they're they're not saying anything,
and we we can't really be sure the I think
the most popular in terms of like people saying, well,
why don't you just do this option is something called prioritization,
which is to make some payments and not others. So
what does that look like? For instance, if the Treasury
sees that they have a payment due to the holder
of a long term Treasury bond, they will make that
(10:53):
coupon payment, but they won't necessarily make a payment to,
for instance, employees of the federal government for their paycheck.
How you assign a matrix of sort of like who
gets paid and who doesn't get paid in that scenario
is a super fraught political question that deserves a lot
of discussion. It's all hypothetical because the Treasury has said, well,
we can't actually do this, We don't have the technical
(11:15):
abilities to do this. Now, they may be bluffing when
they say that one way to sort of get a
better outcome around the death ceiling from the Treasury's perspective,
because if you're the bureaucrats of the Treasury, what you
care about is just being able to do what Congress
has told you to do in terms of making payments
in and out of the Treasure General account. You don't
really care about the political fight. You just want to
do your job, and from that perspective, Treasury has signaled
(11:36):
quite aggressively, Look, we cannot do prioritization. So if if
we hit the X date, then we're not gonna be
able to say, oh, make this payment but not that payment.
Whether that's true or whether that's sort of signaling in
a game that makes default very very costly for whoever
lets it happen is an unclear thing, like like one.
One possible explanation is that Treasury is saying that as
(11:56):
a way to signal to, for instance, congressional Republicans that hey,
y'all can't do this or it's gonna be really really bad.
If Treasury is being honest around prioritization, and again I
don't have any insight, and you know, I don't have
a way to say like, oh, they're not being honest,
but it's definitely possible that they're. They're sort of presenting
a reality that's a little bit less the case than
is other than than it really is. But assuming they're
(12:19):
being honest, then when Treasury runs out of cash, you
come to this second scenario called a general default, and
that is basically saying we're not going to make any
payments to anybody because everyone's on an equal footing. We
can't tell payments apart, and we are just not going
to make payments until the debt ceiling is lifted. That
would be enormously disruptive and would obviously involve an outright
(12:40):
default on certain US securities. There would probably be make goals,
but there would be a default. There would also be
a default on everything from Social Security checks to government
employe paychecks. The military wouldn't get paid, Military contractors don't
get paid, any government contractor would get paid. Cash out
of the Treasury would entirely stop. So I think in
terms of the first two options around like what Treasury
can do in terms of making payments, like the rest
(13:02):
pull in terms of making payments, those are the two extremes.
Absolute prioritization would be they have this matrix of different
priorities and they make them as they're able to, and
some people don't get the payments their owned, but Treasury
is able to finally tune that to like reflect what
they want to do. That's one spectrum, and the other
spectrum is general fault. Nobody gets anything until the debt
gets a little bit, so Obviously, general default of the
(13:41):
US sounds very, very bad and dire. But one of
the things we've seen in previous debt ceiling dramas is
that as we get closer and closer to that prospect,
we tend to see market participants buying US government debt
as a sort of flight to safety play. So what
would it mean for the actual treasury market if we
(14:04):
got to that general default point? What would you expect
to see? Well, that is where things get really fun,
because you have to sort of competing definitions of fund
may vary. Fund may not apply to the non exactly.
So on the one hand, any missed payment on something
(14:24):
that is assumed as a just a general functioning bedrock
principle of financial markets to never miss payments, whether it's
principal or khun having a miss payment on that creates
all sorts of headaches. Not only is are are you
maybe creating four sellers of people who are not allowed
to hold securities that have defaulted? And we can come
(14:45):
back to that later, but let's assume that there's some
segment of the market that says we're not allowed to
hold these. We we we just can't be seen holding these,
So we have to sell them. On the other hand,
some segment of the market would say, look, this is
a political fight. It's not a it's not a lack
of ability to pay, it's a lack of willingness to pay.
That's going to be temporary. So we will accept some
trivial risk premium to hold these securities because at some
(15:06):
point we trust that we're gonna be made whole. You know,
we might lose a little bit, but but you know
we're going to be paid something for holding these defaulted
securities in the meantime, so we'll hold onto those. So
figuring out who has these securities, who has to sell them,
who wants to sell them, what prices there the people
who want to sell them are willing to trade at
versus the other side of the of the demand for
these of ALTI securities by people with a little bit
(15:28):
looser risk tolerance. That's going to be a really there's
been a lot of volatility. As those securities work themselves out,
there will be a series of bills around the debt
ceiling maturity or around the debt ceiling X state that
will be probably the most impacted relative to their historical volatility. Bills.
Remember don't pay coop on payments, so you know, your
whole payment of interest comes with the maturity of the bill,
(15:50):
So you know, as a percentage of of your total
cash flow for the instrument, bills are going to be
a lot more impacted. And they're also much less volatile historically,
so you know, if you if you see for selling,
you can see sort of more outside moves in those
in those word are typically much safer, less volatile securities.
On the other hand, you've got notes, bonds, notes and
bonds which are longer term. You know, if you're thinking
(16:12):
about a third year bond, one missed coupon payment, that
that you know you probably get paid back in cash
a month later. It doesn't really matter as much to
the to the total value of the security. So it's
plausible that you see long term securities that miss coupon
payments during that period outperform the front end of the
Yolker or or or or fall. You know how their
yields fall, prices go up in absolute terms because of
(16:35):
general risk of version. Now there's also a scenario here
where and we're sort of getting far out into hypotheticals
without really stressing what are our metrics for like this
scenario are But there's also a scenario here where basically
there isn't much change in the treasury market because the
people who are willing to pay more and the people
who are forced to sell or want to sell are
(16:55):
relatively evenly matched, and everything kind of just trades out
at equilibrium levels. That's a very real possibility, is it
my expectation? Probably not, But like it's it's something you
have to think about. So one of the things that
makes treasuries special is that they are used for collateral
in the repo market. So you know, if you're loaning
or borrowing a large amount of money, you will often
(17:17):
use treasury securities as your collateral slash security in order
to do that. What would be the impact on the
repo market if you had doubts over whether or not
some of these bonds are in default or are in
fact going to be receiving their coupon payments on schedule.
I think it's probably best to think about the repo
markets an extension of the cash treasury market from that perspective,
(17:39):
And in this scenario, I think there will be some
repo market makers who are willing and able to take
quote unquote defaulted treasuries as collateral and maybe apply some
small haircut to them, but are willing to do it
for a relatively small increase in their income from from
the activity. You know, just like there will be people
who will be willing to pay, you know, slightly less
(18:00):
than than typical for for a similar security because it's defaulted.
But but not like you know half as much, you
know that kind of thing. But we don't really know
the other thing, and I think this affects both the
repo market and the cash market is we don't really
know how well the back end settlement systems and trading
systems are going to handle being able to trade something
(18:20):
that's already past maturity right like and hopefully their QA
and DEV people at banks and at funds and at
other providers who are thinking about this and have have
tested this. But what happens if I have to buy
on recording this February ninth? What happens if I have
to buy on February ninth a bill that shows that
that has a maturity data associated with it a February seven?
(18:42):
Can the systems even accept that? Or it does it
throw an error and say no, you're not allowed to
do that. I'm so glad you brought this up because
this is something I've wondered about exactly, which is that
with most financial instruments, when we're talking about default, you know,
it's just like it's kind of an economic question, well
what's there when you're going to get your recovery, etcetera.
And I've always wondered whether like a US debt default,
(19:02):
like would it almost be more like the Y two
K problems. See this is a crossover episode between the
Y companies have terrible software and the U. S Treasury. No,
this is exactly what I've wondered whether rather whether we're
thinking about it the risks is sort of the wrong dimension,
whether it's actually kind of like creates all just sort
of technical things like here's the one instrument that no
(19:25):
one ever thinks about missing a payment on, etcetera. Right,
it's like, uh, you know, I don't I don't know
what the analogy would be, but I'm glad you brought
this up because it seems like this could be the
one thing. It's like, did they even like code the
possibility that some of these instruments wouldn't get paid and
what kind of like I mean it's kind of specultive, right, Like,
it's hard to answer, but I'm glad you brought this up. Yeah,
(19:48):
I mean I think the team over Hindsight Capital would say, well,
I sure hope they'd this because you know, you've known
it's a possibility. Yeah, when are we gonna get this?
Every single trade their way ahead of things. Um, but yeah,
I mean we've known this is at least the hypothetical
possibility since at least, so you would hope right that
that there have been some efforts to make sure that
(20:10):
settlement systems can handle this sort of thing. But just
because you would hope that doesn't and you can actually
say like, oh, yeah, that's that's how it works. I
know at some level there would be able to be
settlement of treasury securities and defaulted. I mean, you can
do stuff over the phone, you can do stuff with
manual settlement procedures, but there's just no way that the
(20:31):
markets canna be able to handle super high volumes if
everyone's normal trading systems are just not working correctly because of,
for instance, a maturity date that's prior to a settlement date, right, Like,
it's just I think there would probably be some disruptions there.
So you know that adds a liquidity dimension, and you know,
liquidity being withdrawn possibly due to due to issues on
(20:52):
the in the software, on top of the absolute risk
premiums that people are willing to to bear. And you
know this all applies equally to repo to you know, um,
with repos. Instead of thinking like, oh, I want to
buy your sell bond, it's like, oh, if I want
to use this bond as collateral, can my system accept
to this collateral if it's got a date that's later
than you know, same same principles basically. So yeah, I
mean I don't know the answer to any of this,
(21:13):
to be clear, Like I used to work relatively close
to bank settlement systems back at my prior role, but
I haven't been near a bank settlement systems in almost
a decade now, So you know, I I don't know, um,
and I'm not sure anyone anywhere knows with great certainty
what the aggregate trading community, whether it's fast money, real money,
you know, what they can handle in this respect. But um, yeah,
(21:36):
I don't know. So I want to talk about another
you know, go back to this idea or talk about
this idea of you hear payment prioritization, and of course,
as you mentioned, Treasury hasn't assisted. Maybe they're bluffing that.
It's technically they don't have the capability to say shut
off one kind of payments easily while say like making
(21:56):
sure that we continue to pay a debt. But setting
us technical questions of whether they can do that. What
about like the political questions of who gets to decide
what shuts down? Because if you're Biden and it's like, okay,
like we're not gonna pay the military, and look, the
Republicans are preventing the military are brave men and women
(22:17):
from getting paid. Look, and then the Republicans might say, well,
you didn't have to shut down military payment, etcetera. You
could have like done something less impactful, etcetera. But who
gets to decide even a prioritization what doesn't doesn't get paid? Yeah,
I think totally there are deep political questions about every
facet of this whole problem. And I think it does
illustrate so well how debt is a fundamentally political thing.
(22:39):
I mean, we have our constitution because the first crack
post revolution at at creating a structure for governance in
the US didn't handle debt well, like, that's literally why
we have a constitution, the constitution we have today. Obviously
there's more stuff in the Constitution than just management of debt,
but there is a general problem here where you are
taking what was the purview of Congress and elected representatives
(23:04):
in assigning payments to various stakeholders that the Treasury faces
on a on a settlement basis, and you're you're taking
that away and you're handing it to Treasury with no
explicit decision to do so. If you're going to prioritize
without legislation, and there will be no legislation on this,
you know, then Treasury unelective bureaucrats at Treasury are just
being told to make the best of it that they
(23:25):
can and have fun figuring it out. That is not
how a government's supposed to be run, right, I mean,
that's not how a democracy is supposed to function. If
Congress had wanted to delegate prioritization to Treasury and said
that explicitly, that would be a fine whatever, that their purview,
But that's not what's going on here. It's Congress saying, well,
we're not going to do anything, so just do the
best you can and throwing it back to Treasury. And
(23:46):
when you get that outcome, I mean, that's not going
to be good for anybody, regardless of who the winners
and losers Treasury picks are, if they even have the
ability to make those picks. It's it's it's it's a
pretty deep irony that that a representative democratic system is
doing this to itself. And again, I just I want
to emphasize that this is Congress doing it to itself.
This is not this is this is not inherent thing
(24:07):
around that national debt management. This is a series of
bad decisions that have been made by elected representatives over
the past thirty or forty years that have gotten us
to this point. And it's entirely a self inflicted situation.
I think this is such an important point to make,
this idea that debt is ultimately a social construct and
inherently political in many ways. You know, it tells a
(24:29):
story of who owes who what and why, and so
it's immediately caught up in you know, the potential for
different narratives. You mentioned how self defeating a lot of
this tends to be in the US, and it does
seem to put it mildly that defaulting on US debt
would be bad. So what would happen if, you know,
(24:51):
the executive branch just just decided to ignore Congress on this,
Like what if people just go off and you know,
the president goes off and does his own So earlier
we were talking about, I mentioned how fun it would
be if we had a general default and what that
would mean for the treasure market as for the treasury
market functioning fund, same thing for constitutional fund in this
(25:11):
instance that you just described. Um So, just as a
bit of background, if you read section four the fourteenth Amendment,
one of the key reconstruction amendments after the Civil War,
there's a clause that says the validity of the public
dat of the United States, authorized by law, including debts
incurred for payment of pensions and bounties for services and
suppressing insurrection and rebellion, shall not be questioned. So this
is just basically saying, like there's a general constitutional principle
(25:33):
that if the United States government owes someone something, you
can't get in the way of that right like that,
that's the plain text reading of that. How far do
those powers go? It's an it's an interesting question. No,
one's ever really litigated it. This this this clause section
four was mentioned in a in litigation around a new
Deal case, but it wasn't it wasn't really directly established
(25:53):
to be read in a maximalist or minimalist way. Other
parts of the fourteenth Amendment have been litigated to the
end of time. I mean, it is one of the
most litigated parts of the entire Constitution that the Spring
Court heres cases on. But this particular section has very
little litigation associated with it, so we don't really know
what courts would do. But if you read that that
that text, just as you know, sort of a plain text,
(26:15):
then it seems to create a constitutional obligation to pay
the public debt of the United States. And it's one
thing to say, well, you know, we can't pay the
public debt because we've run out of dollars. But we
know you and I, Joe and Tracy and hopefully odd
lots of listeners at this point know that to treasury
creates dollars. In the Federal Reserve creates dollars, and there's
no there's no lack of those dollars there there you
(26:36):
can't run out of them. So that's not that's not
a restraint. What what then, is preventing the federal government,
or specifically the executive branch and the Treasury, from going
out and doing what the Constitution tells it to do
by preventing people from questioning the debt and just saying,
restraints on issuance of debt to make good on payments
(26:56):
owed by the United States to third parties are I'm constitutional.
The dead ceiling is I'm constitutional, and we're going to
keep issuing debt until to to make payments until someone
tells us to stop. That path is one that is
hard to see from a political a political group that
(27:16):
has been as risk averse as the Biden administration has been.
But I do think you can make a very good
case that in an emergency, a situation where there's a
general default, where you know markets are crashing, where you
know there's there's massive economic disruption, that this is a
good choice to be made, that that that the debt
ceiling is totally self defeating. It's a it's a it
(27:37):
shouldn't exists in the first place. And by the way,
there's a constitutional reading right here. Now. I'm not a
constitutional scholar. I'm not a constitutional lawyer. I'm none of
those things. Um, like jay Z said, you know, I
passed the bar, but I know a little bit. I
know enough to know that this could hypothetically work. But
that's about it. So I don't think I would predict
(27:58):
that the bid administration should or could go out and
do this. But it is interesting to think about how
these powers appear to be given to them by the Constitution,
and that there could be a Supreme Court case settled
based on whether the US has just issued bonds that
are illegal under the Constitution. You know. Again fun, So, okay,
(28:23):
we're not going to have like a coin conversation. But
this does get to the other possibility, which is these
technical workarounds that people believe exists in the law. So
one possibility one of these workarounds could be invoked the
fourteenth Amendment, And it seems pretty clear the history on
that does not seem to be particularly ambiguous about why
(28:44):
it's there, And it's kind of you know, I'm reading
on Congress dot gov inspired by the desire to put
beyond question the obligations for the government issued during the
Civil War, and so like, I don't know, like it
doesn't seem particularly ambiguous, but setting aside the fourteenth, talk
to us about some of these other ideas in the
law to avoid a default. I think the easiest one
(29:05):
to understand and easy by the you know, if you
know a little bit of bond math, The easiest one
to understand is this idea of issuing very high coupon bonds.
So when when we issue a bond, typically what happens
is there's a bullet bond. Is the is the standard
term for what people think of, as you know, for instance,
a treasury bond, where you get a series of payments
(29:26):
over time that are called coupons, that are regular small payments,
and then you get a big payment at the end,
which is called the principle. Right principle is you know,
typically you you pay you you quote the price of
a bond as the percentage of the principal payment that
you will receive at the end. So for instance of
bondus trading at that means you pay now and then
you get the series of coupon payments associated with that
(29:47):
bond and the principal payment at the end, which is
a hundred. When Treasury auctions securities they are sensitive to
they basically want to set the price of those securities
just below one when they're first issued. Um, they don't
want to issue bonds at a premium. And they also
have a serious other constraints, like, for instance, the minimum
increment of coupon. So what they'll do is they'll issue
(30:11):
bonds with a coupon that sets the um the principal
payment um or sorry, sets the auction price just below
a hundred when they when they issue. So, for instance,
they're not going to go out and issue a fifteen
coupon coupon bond when the prevailing yield on treasure securities
is like five percent, right like like like, they're never
going to do that. But that's just like an internal
(30:33):
norm that's not like written in law anywhere. They don't
have a legal obligation to do it that way. If
they wanted to, they could go out and issue a
bond that matures with a principal value of a hundred
and pays coupon payments of a hundred, you know, hundred
per year for the next thirty years. Say so let's say,
for instance, they did this, they said, well, we're gonna
issue what's called a super high coupon bond, and again
(30:55):
this is nonsense territory from a from a pure finance perspective.
But let's say they go out and and that bond
that matures thirty years from now at a phase five,
it will pay a hundred and coupons every year as
opposed to the you know, four percent coupon on the
most recently issue third or bond something like that. So
if you do the bond math on that, if you
if you discount all those cash flows back to present
(31:16):
value at the current prevailing interest rate, what you've got
is an eighteen hundred dollar You receive eighteen hundred dollars
today for the bond maturing at a hundred in the future.
And the reason you get that is because it's got
that long string of payments associated with it, whether the
same size as the as the principal payment. You've basically
issued a zero coupon strip, all in one instrument for
(31:37):
the next thirty years. And you've done that, you're the
impact to the debt ceiling is a hundred, but you
now have another seventeen hundred in your in your pocket
because of those coupon payments. Those coupon payments aren't covered
by the debt sailing their coupon payments not principal payments.
Right that when when Treasury counts debt, they're not counting
the coup the interest costs, they're counting the principal value.
(31:59):
So hundred dollars is I mean, like like it's a
technicality where you can say, well, the coupon isn't principal,
but it's still cash in my pocket now delivered at
a later date that doesn't count against the dead ceiling.
So you know, that would be another technical workaround they
could use. Again, this one is on much less dicey
(32:21):
legal footing. There are lots of reasons why Treasury maybe
want to say we don't want to do this, Um,
we don't have any interest in this, we're not able
to do this whatever. There There could be lots of
reasons for that, but but legally it's it's not quite
as dicey as saying to Congress in the Supreme Court, well,
we're just going to keep issuing Debton. You know, take
your best shot at stopping us. I'm trying to think
what would be a harder sell to the public is that,
(32:41):
you know, issuing a high coupon bond that like gets
you immediate proceeds that are a lot more than the
actual issue once amount, or is it a large novelty coin. Well,
I mean, so I was gonna you know, the novelty coin.
I'm sure you know, well, we know the headlines are
gonna be on that. But you know, at the same time,
I'm I'm imagining Biden is borrowing at a hundred percent
(33:03):
interest rates from China to like the payday loan to
like you know, like the the The headlines could go
in either direction, for sure, Yeah, I mean, but then
you have to explain like like what how it's even
possible to borrow a hundred percent interest rates or or
like what is even happening there? I mean, I do
think both the coin for for all it's downsides tracing.
(33:25):
I know how much you love the coin, but you
know the benefit of both the high coupon bond plan
and the coin plan is that they're weird incantations, you know,
run by technocrats. They're not They're not like a tangible
thing where it's like the U. S Constitution and like
this sort of feeling that the world is going straight.
It's like, oh, well they said the right words and
(33:46):
everything is fixed now. So who cares is is how
people tend to think about this stuff. I think. Whereas
when you're talking about the Supreme Court and the Constitution
and Article um section four of the fourteenth Amendment and
the history and that, people get very arpen arms all
the Constitution, you know whatever. Whereas if it's just like, oh,
well we just said the right words magically to the
bond market and now everything's fine, I think you get
a very different you know, feeling from that politically. But
(34:10):
that's speculation on that part. This is something that's important,
which is that okay, let's say the administration to say,
you know what, the fourteenth Amendment says, the dead sailing
is invalid. We're just going to ignore it and continue
fiscal operations as normal. And then, as you pointed out,
there might be some ambiguity about whether the bonds issued
after that moment are legal, and maybe there would be
(34:30):
get to the Supreme Court. We don't really know what
they were going to say. But to some extent, this
even applies to any other solution as well, including the
high coupon bonds, including the coin, which is that like
someone could sue over the coin, Like no one's gonna
stop it. And if like five out of the nine
Supreme Court justices says you can't issue a hundred year bonds,
like that's clearly in violation to the spirit of the
(34:53):
dead Sailing law. You know, you're still issuing debt at
a time when we're not supposed to issue any more
debt Like the uncertain the exist in almost any of
these scenarios for sure. And you know we set it before,
and I'll say it again, this is all a political question,
a social question, right like that, Like political power means
telling people to do something that they don't want to do.
(35:14):
That is what political power is, right, And whether it's
the Biden administration forcing issuance of new debt, whether it's
the Supreme Court stepping into either validate that or or
or invalidate that. You know, that's the fourteenth a medi scenario,
or whether it's the Biden administrations saying, Okay, we're not
going to make any payments regardless of who doesn't get paid,
or it's prioritization where some people get paid, for instance,
(35:37):
bond holders maybe get paid, but you know, retirees don't
like whatever approach you take to this. At some point
someone is being told you don't get what you want
because you can't stop me, you know, under our system,
right like like you physically can't stop me, or you know,
enough of other political bodies have sided with me so
that you can't get done what's what you want to
get done? And you know this is a like at
(36:00):
the end of the day, the dead ceiling has lots
of interesting financial and economic and analytical things to explore,
but it's always going to come back to being a
political problem. Was created by politicians. It's it's being exacerbated
by politicians, and it will be solved through political means
and nothing else. And you know, I just I'll always
come back to that. I I really in that. From
(36:22):
that perspective, I cannot emphasize enough that that Congress has
created this problem for itself, and if there was justice,
then Congress would lose power in some sense over this,
whether it's the death ceiling is invalidated by the Supreme
Quarter or by the by administration or whatever, or you know,
some other solution. Unfortunately, like the world doesn't work based
on karmic justice, So I don't think we can hope
(36:44):
that oh well, the you know, Congress gets its come
up in but maybe they will. I mean, we'll see.
I mean, it's gonna be an interesting few months here,
to say the least. So the overarching theme of this
(37:09):
conversation is just mass uncertainty, lots of hypothetical shooting out
in every different direction, and no one really knows what's
going to happen when we finally hit that X date,
the drop dead date. But there is something sort of
more immediate, a potential more immediate impact. And I think
we touched on this when we were talking about t
(37:29):
g A balances, this idea of you know, the Treasury
is checking account at the Fed. It does have an
impact on liquidity. So what's going on with the t
g A. You know, if there's more money in there,
if there's less money in there, it can mean different
levels of liquidity for the broader economic system, for companies
that might be due payments from the government. Talk to
(37:51):
us a little bit about the immediate impact of all
this discussion over the debt ceiling on market liquidity and
money harry policy as well. Yeah, so this is kind
of a perverse thing about how the mechanics of of
the t g A being inflated with that sort of
cushion we discussed earlier. It's perverse how this works, because
(38:12):
when the Treasury is building up that cushion, they are
withdrawing aggurate liquidity from the private sector. Treasury is withdrawing
liquidity from the private sector because that increase in t
g A balances is being funded by some combination of
higher debt and you know, higher tax as relative depending
it's debt, right, the Treasury is issuing more bills and
(38:33):
more notes and bonds than they technically need for the
specific period in time. That means cash balances are being
dragged out of the private sector and to the Treasury's
cash balance. At the FED, that's a federal reserve liability,
just like a FED fund is, but in the but
the liability that the FED holds in the t g A,
the only asset, the only person who can hold that
as an asset is Treasury, whereas Federal reserve FED funds
(38:56):
are an asset that can be held by the banking
sector and used to match against deposits that are an
asset of the rest of the private sector. So basically
it's like reverse quite right, when this TJ is being
built up, it's it's it's pulling liquidity out of the
private sector and storing it in the t g A.
Then the t as the t J is released, it
does the opposite, right, so it unleashes private sector liquidity
(39:20):
because that liability of the Federal of the Federal Reserve
to the Treasury is being spent down. The payments are
wounding up as assets of the rest of the private
sector or the rest of the world. Basically, everybody but
the federal government funded by Federal Reserve FED funds liabilities
of the of the FED. So it's basically a countercyclical thing,
right Like it's it's as as times are good and
(39:41):
we're you know, go along and t g gets built
up and then we've got worried about that ceiling. But
at the same time, a bunch of liquidity as being unleashed. Now,
the sizes here are not necessarily huge. It sort of
depends on the specific instance. But the size of the
t g A has gotten pretty big relative to the
rest of the Fed's balance sheet as a matter of course.
(40:01):
So prior to the global financial crisis two thousand seven,
two eight kind of range, the TJA was less than
one percent of the FEDS balance sheet. Basically payments in
payments out almost precisely matched each other day to day.
From two eight fifteen, it built up a little bit
because just the scope of federal government spending went up.
There was a lot more issuance of debt with post
crisis deficits that were that slowly sort of declined from
(40:24):
the peaks in two thousand nine. But then when we
get to and treasure says, okay, well we want to
start building up this this cash balance from average six
percent of the Fed's balance sheet UM so it was
below one percent before the goal financial crisis immediately after
is about two after that. After six since q it's
been eleven percent of the FEDS balance sheet. That's a
(40:44):
huge percentage of the FEDS balance sheet, and it swings
around quite a lot, unlike, for instance, the q AST
purchase portfolio. So basically you've got this complicating factor that
has nothing to do with the FEDS monetary policy UM
setting that the FEDS, the FED is not changing policy
based on treasury cash management, and yet it's got this
this sort of impact on aggregate private sector liquidity, both
(41:07):
positive and negative depending on what's going on with the
t g A UH, do you have to account for
so you know, as we see the t g A
spend down over the next few months, it's already underway. Um,
that will have an impact on aggregate private sector liquidity.
That will be kind of sort of counterintuitive. I guess
you could say. Right now, there's about five hundred and
sixty billion in the Treasure General account. That's down from
(41:31):
a peak of almost a trillion in May of last year.
The recent peak, it's it's it's it's sort of trended
lower over the past seven months or so, and that
will continue to trend lower as we go from five
sixty down to zero presumably or near zero at the
X date. All right, I want to ask one more
markets related question, and I think there's this fantasy that
(41:52):
people have, which is that the stock market becomes the
sort of forcing mechanism. The example that everyone would site
is the tarp out. It failed in two thousand and eight,
and the stock market crashed some more, and then they
passed it a couple of days later. It doesn't seem
like that dynamic really holds with the dead ceiling, because
even though there's this potential for catastrophe, on certainty, the
(42:14):
view amongst stocks investors seems to be they always get
it done in the end. Why would I sell my stock, etcetera.
Like can you talk a little bit about, like, as
we get closer, is there any sort of like history
or like the sort of interplay between market volatility and
pressure to just like all right, let's get it past.
There is no doubt that there is a feedback loop
(42:35):
between asset markets and how politicians think in this country.
I mean, using a more recent example from then the
top vote, which I think is a good, good one,
you could look to what happened in the spring of right,
we saw a degree of fiscal stimulus and a degree
of support for households that completely unprecedented in American history
and completely like if you had dreamed up the scenario
(42:57):
where that happens, even if you had you know, no
one about COVID coming, and you had said, okay, well,
then you're going to see this public sector response to that,
I don't think anyone would have believed you. They just said, no,
there's no way that the Republican Congress will will do that.
There's no way that there are no Republicans and Congress
will okay that, There's no way that I'll get through
filibusters and all that, and it absolutely did, and it
(43:18):
did so immediately because asset markets were in free fault
right there. There is a lot more feedback to political
economy in this country and to political out comes in
this country from the stock market then from the unplaying right.
That is just how things work. I'm not defending that,
it's just the reality. So I do think that if
we if we see stock markets start to false you know, measurably,
(43:40):
you know, like like big volatility, big downside in the
months or weeks leading up to the sort of X
state as it sort of becomes more clear, then you
will definitely seem a lot of pressure on politicians to
to just just raise the dang thing, you know, have
your fights about something else. Whether that comes from people
within the respective ideological goals of each party, whether that
(44:01):
comes from the public as a whole, it's unclear, but
either way there will be significant pressure. If, however, stock
markets say, well, you know, like they'll figure it out
and event you know, maybe there there'll be a default,
but like they'll pay those back eventually, and people be
commented and like area with plenty of people that are
willing to pick up an extra twenty five basis points
in a Treasury bill to hold it for a few
months while they figure out this, this this out and
(44:22):
it'll be fine, and so we can just sort of
look past that. If if that happens, that's a recipe
for a much more protracted fight and a much longer
time past the X date with you know, uncertainty going on. Now.
My view would be that if you if you get
to the X date, even if you have prioritization, barring
using one of the technical workarounds we discussed, so either
the coin or using high coupon bonds or um just
(44:45):
saying well, this violates the fourteenth Amendment, so we're going
to ignore the death ceiling if you if you you know,
don't have those and you have either prioritization, which Treasury
said isn't possible but could be possible and you're working
through prioritization, or if you're just doing a general default,
We're we're not paying any payments until the dead ceilings race,
because that's that's what the law tells us to do.
If if I'm the Treasury, okay, either way in either
(45:06):
a prior to a severe prioritization scenario or a general default,
you're going to have large economic impacts from that, right,
Like like that, the volume of outgoing payments that are
not going to show up in the bank accounts of
people that want to spend them, whether those are businesses
whether their individuals, is going to be really big. Social
Security is a really good example. Like if you start
paying Social Security, the entire economy grants to a halt
(45:27):
about a month. There's just not it's it's just such
a huge cash flow for such a large percentagers of
population that you can't So eventually there will be a
feedback to asset markets. This will not last forever where
it's just kind of the new normal that the US
is permanently you know, has the destiny in place, and
you know, only making some outgoing payments. Eventually the economy
starts to collapse, the stock market starts to collapse, and
(45:48):
you you know, you see and another interesting thing, just
to work it back to the Fed. An interesting thing
to think about it is if the economy is collapsing
because all these payments aren't going out and the stock
market is in free fault us, the FED step in
to say, okay, well we're going to cut rates now.
Because the economies and free fall because of what's going
on with the dead sailing or do they say not
our problem? I don't know. I don't have a good
(46:10):
answer for that. I don't I don't think a good
answer exists, but it's something interesting to think about. It
feels like this is one of those topics where there
just aren't a lot of good answers. But George did
a good job. Yeah, you did a great job. There's
a lot of uncertainty and hypotheticals as we've been talking about.
It's not an easy thing to sort of lay out
all the different options and what might happen depending on
what's pursued. But George, it was great having you on.
(46:32):
You did a great job. Thank you so much. Yeah,
thanks for having me on. I mean I can stick
around for another three hours and we can get all
the different hypotheticals if you want. All right, now our
to the coin conversation. Okay, I'm thanks man, let's go.
Thanks for having me on, George. Thanks George. Joe. There's
(47:03):
a lot to unpack from that conversation. I agree, But
George did like a great job, Like you know, there
is a lot of uncertainty. I guess because it's something
that had been lodged in my mind. But like, I'm
glad he brought up that question of like the software
element of defaulted debt, because it's just something like I
want like people like you know, like we don't talk
about debt in those terms. It seems totally like a
(47:25):
Y two K thing, as you mentioned, where people just
would not expect US treasuries to default. And anyway, why
would you prepare for such a scenario, because if that
were to happen, then it would be the collapse of
the financial system as we know it. But yet here
we are, you know, after two thousand eleven, after having
a very similar conversation. The other thing that's stuck out
(47:47):
in my mind was George's point about, you know, ultimately
this is a political process and it plays out in debt.
But the reason it plays out in the debt market
is because debt is inherently, I think, so tied up
with questions of morality and justice, and it's so easy
(48:07):
to build a political narrative on top of something that
is ultimately about who owes what to who and why? Absolutely,
And you know, I think that's why it's really notable
that this was written into the constitution, and we run
into the constitution after the Civil War. And what we
did have that coin conversation was with Roman Grande. He
(48:28):
talked about this as well, which is that like this
fear that in the pursuit of the Civil War that
southern representative representatives from the formerly confederate state would try
to induce a default because it's like, oh, we don't
want to pay the debts of the northern government that
fought a war against does and so they did, like
they this is like, you know, it gets to like
(48:50):
deep constitutional questions and it continues to play out over
and over again in different forms, the political weaponization of debt.
It seems to be happening more often because I think
people have realized that it is an effective pressure point.
As George laid out well on that happy note. Shall
we leave it there, Let's leave it there. Okay. This
has been another episode of the Odd Thoughts podcast. I'm
(49:11):
Tracy Alloway. You can follow me on Twitter at Tracy
Alloway and I'm Joe Why Wasn't Though. You can follow
me on Twitter at the Stalwart. George doesn't really tweet anymore,
but maybe he'll come back one day, so I'll plug
it anyway. His handle is at Perks. Follow our producer
Carmen Rodriguez at Carmen Armand and Dash Bennett at dashbot.
And check out all of our podcasts at Bloomberg. Under
(49:33):
the handle at podcasts and some more odd Lots content.
Go to Bloomberg dot com slash odd Lots when we
push the transcripts. We have a blog, a weekly newsletter
that goes out every Friday. Go there, sign up. Thanks
for listening. See to
Hello, and welcome to another episode of the ad Thoughts Podcast.
I'm Tracy Alloway and Joe uh debt ceiling. Oh, I'm
so excited we're doing a trillion dollar coin episode. I
knew you were going to say that and to annoy me. Yes,
this is not an episode on the trillion dollar coin.
(00:30):
If you are interested in that particular piece of um
finance thought experiment, you can check out our previous episode
on the topic. I think it was over an hour long,
all about the trillion dollar coin. Yeah, okay, check out
that episode if you want to talk about the trillion
dollar coin. But today we're going to be discussing something
(00:51):
slightly different. We are going to be talking about what
exactly happens if the US actually does default, right, because
if there's like just a lot of uncertainty about this
question of like okay, like what happens if they don't
raise the dead ceiling? And what are the constraints, what
are the various things that could happen, Like how bad
(01:11):
would it be if we actually, like didn't pay the debt?
Does the White House have ability to pay some debt
but not others? Like it's pretty uncertain, Like it seems
bad right, like it is lame and defaulting was bad.
Russia default was bad, and Russia is like this like tiny?
You know how big was russia debt nothing? So like
(01:34):
it is a moving feast of uncertainty, like a twirling
whirlwind of chaos and uncertainty and open questions over exactly
what happens. And there are all these moving parts. I
think we really need to sit down and discuss them
and kind of talk about it in an almost sequential way,
like this is what happens if this happens, and then
(01:54):
that happens. So we really do have the perfect guest
for this. We're going to be speaking with Joe Perks
and add thoughts favorite of course, he is also global
macro strategist over at Bespoke Investment Groups. So George, thank
you so much for coming back on all thoughts. Hey all,
thanks for having me. Let's start with the basics, since
we're talking about this as a sort of primer episode
(02:17):
on the debt ceiling and the debt limit. When we
talk about limits on US debt, what do we mean exactly?
So the US is really unique in a very frustrating
way in that not only do we have restraints on
spending in terms of Congress authorizing and the President signing
(02:37):
into law bills that create government spending um and then
appropriations processes after that, you know, throughout the year, we
also have this break on the total amount of debt
that can be issued. So Congress can at the same
time instruct the government bureaucracies to go out and spend money,
but at the same time say, oh, well, you can't
(02:58):
actually issue debt to you that spending we've told you
to do. And oh, by the way, you can't collect
anymore in taxes because we also control that and we've
told you the amount you can collect in taxes. So
it's this contradiction in terms of instructions to the executive
branch and to various federal government bureaucracies from Congress and
from the President, and it's it's a thing that's been
around in US politics for a long time. But you know,
(03:21):
I think the most important thing to understand about it
is that it's just it's nonsensical. It doesn't make sense
for there to be this extra restraint on top of
the existing safeguards against you know, in a representative democracy
where people are elected and then they authorize the spending
on behalf of the population. We also have this thing
where there's a debt, there's a debt limit that that
(03:42):
serves as sort of a secondary veto point on government spending.
Defenders of the debt ceiling law would say, look, kind
of that's true, but it is good to have this
debate every couple of years about our level of indebtedness.
This can be used as a break of sorts for
or constraining spending. In the Dead Ceiling fight, there really
(04:04):
was cuts and the cuts to the growth of federal spending.
You know, you're saying, like, okay, like this is like
the sort of like maddening law makes no sense. Does
the dead ceiling have a history of like being used
to sort of regroup and retrain our thoughts about how
much we're spending. The short answer is no. And I
think that the more consistent way to think about it
(04:24):
historically is that it's used by one factionum or another
in US politics against whoever happens to sort of be
the party in control. So you know, this is this
is a bi partisan thing. It's used both ways. Both
parties have declined to get rid of the dead ceiling
on a permanent basis when they've been empowered. So I
don't mean to say that this is a red versus
blue you know, one side an abuser of this versus
(04:47):
the other. But what it does is it just it
creates a veto point and allows the legislative minority to
extract what it wants from or some of what it
wants from the legislative majority. Now that's not necessarily the
end of the w old, but there are a couple
of things to think about here. First, the U S
system of government is already full of veto points, right,
whether it's process of buils through committees, process of builds
(05:08):
through the House, process of builds through the Senate, judicial
checks on all that, the executive branch, the high requirement
in the Senate to sign things in the law. There
are some exceptions, but basically you need a supermajority in
the Senate to get things signed in the law. So
there's just we have a replete number of veto points,
adding you know, just one more. The benefits are pretty
negligible even if you agree that that. You know, controlling
(05:31):
the debts size is a super important public policy goal.
I don't happen to agree with that, but let's take
that as given. Even then, there are costs associated with
this that that are very real. And the cost is
the credibility of the U. S is ability to pay
its debts on time in full. And you know, there
are real questions about the United States Treasuries ability to
settle out coupon and interest payments on debt, let alone,
(05:53):
payments to Social Security recipients, payments to government contractors, government employeescetera, etcetera.
This year because of this death ceiling being present. And
again I think it's really important to emphasize debt ceiling
being present. Even though those payments, all those payments that
are set to go out, all the spending, all the
payments that are set to come into the treasury and
formed taxes, all of that has already been approved by Congress.
(06:13):
The debt ceiling is a secondary approval's process that has
nothing to do with keeping a lid on on spending
in a direct sense. So, George, you you just set
out the stakes kind of perfectly there. But talk to us.
You also mentioned the treasury. Talk to us about extraordinary measures,
because the U. S. Treasury has already said that it's
(06:34):
started to take these extraordinary measures in order to meet
its obligations because we have in fact already exceeded that
thirty one point four trillion dollar or whatever it is
borrowing limit. What are the extraordinary measures and how do
they actually play out here? So there are a variety
of things that go into the extraordinary measures behind the scenes.
(06:55):
I mean, the simplest way to think about it is
changing timing of payments and sort of where there's flexibility
to defer payments or to pay them, you know, without
issuing debts, to wait for new payments to new tax
payments to come in before sending out existing payments. That's
one way to think about it. The most important thing, though,
is spending down the balance that's recorded in the Treasury
(07:18):
General account at the Federal Reserve. So the Federal Reserve
is the United States Treasuries fiscal agent, which basically means
that that payments are being made via the feed. So
if you're if you're the Treasury, you don't have a
checking account at a private bank. You have a checking
account at the Fed. There are ways in which the
government is nothing like household, but in terms of access
(07:41):
to a checking account, that is one way the government
is like a household. There is a account at the
Fed again called the Treasury General Account that is essentially
a cash balance, a balance available for payments that is
used to settle payments owed by the Treasury to other
individuals or entities throughout the economy. And what the Treasury
has been able to do since whether they're able to
(08:03):
do it beforehand, but what if they've done as a
matter of course since, is build up this this Treasure
General Account in the period leading up to debt ceiling
limits being reached, because that allows for flexibility over the
subsequent months. Basically, if you know that you're going to
be without a paycheck for a couple of months, you
save some cash away and your checking account. You're not
(08:24):
going to buy a long term investment with it because
you know you'll need it, but you'll have a little
balance in your checking account, and then when your paycheck
doesn't come through, you can still pay your rent for
a couple of months. You can't do it indefinitely, but
you have this sort of cushion there, and that's sort
of what the charge of General Account spend down is
and that's the core of extraordinary measures that that allows
the Treasury to continue to make all the payments it's
mandated to buy law, you know, whether that's UH payments
(08:45):
to contractors, payments to employees, payments to beneficiaries, whatever, payments
to holders of the national debt. All those can continue
to go out the door as normal, in part because
there's this cash balance at the t g A that's
being spent down. Okay, we have these sort of like
they're called extraordinary measures, but they're not like that weird.
They're like little like they're more like, you know, short
(09:06):
term cash management techniques that allow the government to make
its obligations for a few extra months. Let's talk about like, okay,
when those run out, what happens? Like where where do
things stand? You know? People talk, I don't know, like
what is your estimate for when like the sort of
real debt limit is right when we no longer have
(09:26):
these sort of drop dead Yeah, so the X date
the drop dead date? Talk about like what happens as
we get closer to that. I so, I personally don't
think my estimate is any better than what we've heard
from charity or from the Secretary Treasury yelling, she says
June five, this sort of her best estimate, but one,
It's important to understand that she described it as having
considerable uncertainty. So, for instance, if we have a really
(09:49):
really strong tax collection season or really really weak tax
collection season over the next three months, that's going to
have big implications for the timing here, right, just because
a huge percentage of cash flows in and out of
the Treasury take lace over over tax season. So you know,
there's just all sorts of uncertainties. Also, private sector of
visibility is is not great into all the timing of
payments in there and their size. So I'll just make
(10:09):
that you know, I think sometime in May June is
probably the right way to think about it. Um, late mate,
early June, we'll we'll hit this drop dead day where
essentially there are more payments being requested from the Treasury
than there is cash balance plus payments being made to
the Treasury. At that point, I think it's important to
stress that we don't actually know what's going to happen.
Nobody knows. There may be Treasury bureaucrats somewhere that know, um,
(10:32):
but for all intents and purposes, they're they're not saying anything,
and we we can't really be sure the I think
the most popular in terms of like people saying, well,
why don't you just do this option is something called prioritization,
which is to make some payments and not others. So
what does that look like? For instance, if the Treasury
sees that they have a payment due to the holder
of a long term Treasury bond, they will make that
(10:53):
coupon payment, but they won't necessarily make a payment to,
for instance, employees of the federal government for their paycheck.
How you assign a matrix of sort of like who
gets paid and who doesn't get paid in that scenario
is a super fraught political question that deserves a lot
of discussion. It's all hypothetical because the Treasury has said, well,
we can't actually do this, We don't have the technical
(11:15):
abilities to do this. Now, they may be bluffing when
they say that one way to sort of get a
better outcome around the death ceiling from the Treasury's perspective,
because if you're the bureaucrats of the Treasury, what you
care about is just being able to do what Congress
has told you to do in terms of making payments
in and out of the Treasure General account. You don't
really care about the political fight. You just want to
do your job, and from that perspective, Treasury has signaled
(11:36):
quite aggressively, Look, we cannot do prioritization. So if if
we hit the X date, then we're not gonna be
able to say, oh, make this payment but not that payment.
Whether that's true or whether that's sort of signaling in
a game that makes default very very costly for whoever
lets it happen is an unclear thing, like like one.
One possible explanation is that Treasury is saying that as
(11:56):
a way to signal to, for instance, congressional Republicans that hey,
y'all can't do this or it's gonna be really really bad.
If Treasury is being honest around prioritization, and again I
don't have any insight, and you know, I don't have
a way to say like, oh, they're not being honest,
but it's definitely possible that they're. They're sort of presenting
a reality that's a little bit less the case than
is other than than it really is. But assuming they're
(12:19):
being honest, then when Treasury runs out of cash, you
come to this second scenario called a general default, and
that is basically saying we're not going to make any
payments to anybody because everyone's on an equal footing. We
can't tell payments apart, and we are just not going
to make payments until the debt ceiling is lifted. That
would be enormously disruptive and would obviously involve an outright
(12:40):
default on certain US securities. There would probably be make goals,
but there would be a default. There would also be
a default on everything from Social Security checks to government
employe paychecks. The military wouldn't get paid, Military contractors don't
get paid, any government contractor would get paid. Cash out
of the Treasury would entirely stop. So I think in
terms of the first two options around like what Treasury
can do in terms of making payments, like the rest
(13:02):
pull in terms of making payments, those are the two extremes.
Absolute prioritization would be they have this matrix of different
priorities and they make them as they're able to, and
some people don't get the payments their owned, but Treasury
is able to finally tune that to like reflect what
they want to do. That's one spectrum, and the other
spectrum is general fault. Nobody gets anything until the debt
gets a little bit, so Obviously, general default of the
(13:41):
US sounds very, very bad and dire. But one of
the things we've seen in previous debt ceiling dramas is
that as we get closer and closer to that prospect,
we tend to see market participants buying US government debt
as a sort of flight to safety play. So what
would it mean for the actual treasury market if we
(14:04):
got to that general default point? What would you expect
to see? Well, that is where things get really fun,
because you have to sort of competing definitions of fund
may vary. Fund may not apply to the non exactly.
So on the one hand, any missed payment on something
(14:24):
that is assumed as a just a general functioning bedrock
principle of financial markets to never miss payments, whether it's
principal or khun having a miss payment on that creates
all sorts of headaches. Not only is are are you
maybe creating four sellers of people who are not allowed
to hold securities that have defaulted? And we can come
(14:45):
back to that later, but let's assume that there's some
segment of the market that says we're not allowed to
hold these. We we we just can't be seen holding these,
So we have to sell them. On the other hand,
some segment of the market would say, look, this is
a political fight. It's not a it's not a lack
of ability to pay, it's a lack of willingness to pay.
That's going to be temporary. So we will accept some
trivial risk premium to hold these securities because at some
(15:06):
point we trust that we're gonna be made whole. You know,
we might lose a little bit, but but you know
we're going to be paid something for holding these defaulted
securities in the meantime, so we'll hold onto those. So
figuring out who has these securities, who has to sell them,
who wants to sell them, what prices there the people
who want to sell them are willing to trade at
versus the other side of the of the demand for
these of ALTI securities by people with a little bit
(15:28):
looser risk tolerance. That's going to be a really there's
been a lot of volatility. As those securities work themselves out,
there will be a series of bills around the debt
ceiling maturity or around the debt ceiling X state that
will be probably the most impacted relative to their historical volatility. Bills.
Remember don't pay coop on payments, so you know, your
whole payment of interest comes with the maturity of the bill,
(15:50):
So you know, as a percentage of of your total
cash flow for the instrument, bills are going to be
a lot more impacted. And they're also much less volatile historically,
so you know, if you if you see for selling,
you can see sort of more outside moves in those
in those word are typically much safer, less volatile securities.
On the other hand, you've got notes, bonds, notes and
bonds which are longer term. You know, if you're thinking
(16:12):
about a third year bond, one missed coupon payment, that
that you know you probably get paid back in cash
a month later. It doesn't really matter as much to
the to the total value of the security. So it's
plausible that you see long term securities that miss coupon
payments during that period outperform the front end of the
Yolker or or or or fall. You know how their
yields fall, prices go up in absolute terms because of
(16:35):
general risk of version. Now there's also a scenario here
where and we're sort of getting far out into hypotheticals
without really stressing what are our metrics for like this
scenario are But there's also a scenario here where basically
there isn't much change in the treasury market because the
people who are willing to pay more and the people
who are forced to sell or want to sell are
(16:55):
relatively evenly matched, and everything kind of just trades out
at equilibrium levels. That's a very real possibility, is it
my expectation? Probably not, But like it's it's something you
have to think about. So one of the things that
makes treasuries special is that they are used for collateral
in the repo market. So you know, if you're loaning
or borrowing a large amount of money, you will often
(17:17):
use treasury securities as your collateral slash security in order
to do that. What would be the impact on the
repo market if you had doubts over whether or not
some of these bonds are in default or are in
fact going to be receiving their coupon payments on schedule.
I think it's probably best to think about the repo
markets an extension of the cash treasury market from that perspective,
(17:39):
And in this scenario, I think there will be some
repo market makers who are willing and able to take
quote unquote defaulted treasuries as collateral and maybe apply some
small haircut to them, but are willing to do it
for a relatively small increase in their income from from
the activity. You know, just like there will be people
who will be willing to pay, you know, slightly less
(18:00):
than than typical for for a similar security because it's defaulted.
But but not like you know half as much, you
know that kind of thing. But we don't really know
the other thing, and I think this affects both the
repo market and the cash market is we don't really
know how well the back end settlement systems and trading
systems are going to handle being able to trade something
(18:20):
that's already past maturity right like and hopefully their QA
and DEV people at banks and at funds and at
other providers who are thinking about this and have have
tested this. But what happens if I have to buy
on recording this February ninth? What happens if I have
to buy on February ninth a bill that shows that
that has a maturity data associated with it a February seven?
(18:42):
Can the systems even accept that? Or it does it
throw an error and say no, you're not allowed to
do that. I'm so glad you brought this up because
this is something I've wondered about exactly, which is that
with most financial instruments, when we're talking about default, you know,
it's just like it's kind of an economic question, well
what's there when you're going to get your recovery, etcetera.
And I've always wondered whether like a US debt default,
(19:02):
like would it almost be more like the Y two
K problems. See this is a crossover episode between the
Y companies have terrible software and the U. S Treasury. No,
this is exactly what I've wondered whether rather whether we're
thinking about it the risks is sort of the wrong dimension,
whether it's actually kind of like creates all just sort
of technical things like here's the one instrument that no
(19:25):
one ever thinks about missing a payment on, etcetera. Right,
it's like, uh, you know, I don't I don't know
what the analogy would be, but I'm glad you brought
this up because it seems like this could be the
one thing. It's like, did they even like code the
possibility that some of these instruments wouldn't get paid and
what kind of like I mean it's kind of specultive, right, Like,
it's hard to answer, but I'm glad you brought this up. Yeah,
(19:48):
I mean I think the team over Hindsight Capital would say, well,
I sure hope they'd this because you know, you've known
it's a possibility. Yeah, when are we gonna get this?
Every single trade their way ahead of things. Um, but yeah,
I mean we've known this is at least the hypothetical
possibility since at least, so you would hope right that
that there have been some efforts to make sure that
(20:10):
settlement systems can handle this sort of thing. But just
because you would hope that doesn't and you can actually
say like, oh, yeah, that's that's how it works. I
know at some level there would be able to be
settlement of treasury securities and defaulted. I mean, you can
do stuff over the phone, you can do stuff with
manual settlement procedures, but there's just no way that the
(20:31):
markets canna be able to handle super high volumes if
everyone's normal trading systems are just not working correctly because of,
for instance, a maturity date that's prior to a settlement date, right, Like,
it's just I think there would probably be some disruptions there.
So you know that adds a liquidity dimension, and you know,
liquidity being withdrawn possibly due to due to issues on
(20:52):
the in the software, on top of the absolute risk
premiums that people are willing to to bear. And you
know this all applies equally to repo to you know, um,
with repos. Instead of thinking like, oh, I want to
buy your sell bond, it's like, oh, if I want
to use this bond as collateral, can my system accept
to this collateral if it's got a date that's later
than you know, same same principles basically. So yeah, I
mean I don't know the answer to any of this,
(21:13):
to be clear, Like I used to work relatively close
to bank settlement systems back at my prior role, but
I haven't been near a bank settlement systems in almost
a decade now, So you know, I I don't know, um,
and I'm not sure anyone anywhere knows with great certainty
what the aggregate trading community, whether it's fast money, real money,
you know, what they can handle in this respect. But um, yeah,
(21:36):
I don't know. So I want to talk about another
you know, go back to this idea or talk about
this idea of you hear payment prioritization, and of course,
as you mentioned, Treasury hasn't assisted. Maybe they're bluffing that.
It's technically they don't have the capability to say shut
off one kind of payments easily while say like making
(21:56):
sure that we continue to pay a debt. But setting
us technical questions of whether they can do that. What
about like the political questions of who gets to decide
what shuts down? Because if you're Biden and it's like, okay,
like we're not gonna pay the military, and look, the
Republicans are preventing the military are brave men and women
(22:17):
from getting paid. Look, and then the Republicans might say, well,
you didn't have to shut down military payment, etcetera. You
could have like done something less impactful, etcetera. But who
gets to decide even a prioritization what doesn't doesn't get paid? Yeah,
I think totally there are deep political questions about every
facet of this whole problem. And I think it does
illustrate so well how debt is a fundamentally political thing.
(22:39):
I mean, we have our constitution because the first crack
post revolution at at creating a structure for governance in
the US didn't handle debt well, like, that's literally why
we have a constitution, the constitution we have today. Obviously
there's more stuff in the Constitution than just management of debt,
but there is a general problem here where you are
taking what was the purview of Congress and elected representatives
(23:04):
in assigning payments to various stakeholders that the Treasury faces
on a on a settlement basis, and you're you're taking
that away and you're handing it to Treasury with no
explicit decision to do so. If you're going to prioritize
without legislation, and there will be no legislation on this,
you know, then Treasury unelective bureaucrats at Treasury are just
being told to make the best of it that they
(23:25):
can and have fun figuring it out. That is not
how a government's supposed to be run, right, I mean,
that's not how a democracy is supposed to function. If
Congress had wanted to delegate prioritization to Treasury and said
that explicitly, that would be a fine whatever, that their purview,
But that's not what's going on here. It's Congress saying, well,
we're not going to do anything, so just do the
best you can and throwing it back to Treasury. And
(23:46):
when you get that outcome, I mean, that's not going
to be good for anybody, regardless of who the winners
and losers Treasury picks are, if they even have the
ability to make those picks. It's it's it's it's a
pretty deep irony that that a representative democratic system is
doing this to itself. And again, I just I want
to emphasize that this is Congress doing it to itself.
This is not this is this is not inherent thing
(24:07):
around that national debt management. This is a series of
bad decisions that have been made by elected representatives over
the past thirty or forty years that have gotten us
to this point. And it's entirely a self inflicted situation.
I think this is such an important point to make,
this idea that debt is ultimately a social construct and
inherently political in many ways. You know, it tells a
(24:29):
story of who owes who what and why, and so
it's immediately caught up in you know, the potential for
different narratives. You mentioned how self defeating a lot of
this tends to be in the US, and it does
seem to put it mildly that defaulting on US debt
would be bad. So what would happen if, you know,
(24:51):
the executive branch just just decided to ignore Congress on this,
Like what if people just go off and you know,
the president goes off and does his own So earlier
we were talking about, I mentioned how fun it would
be if we had a general default and what that
would mean for the treasure market as for the treasury
market functioning fund, same thing for constitutional fund in this
(25:11):
instance that you just described. Um So, just as a
bit of background, if you read section four the fourteenth Amendment,
one of the key reconstruction amendments after the Civil War,
there's a clause that says the validity of the public
dat of the United States, authorized by law, including debts
incurred for payment of pensions and bounties for services and
suppressing insurrection and rebellion, shall not be questioned. So this
is just basically saying, like there's a general constitutional principle
(25:33):
that if the United States government owes someone something, you
can't get in the way of that right like that,
that's the plain text reading of that. How far do
those powers go? It's an it's an interesting question. No,
one's ever really litigated it. This this this clause section
four was mentioned in a in litigation around a new
Deal case, but it wasn't it wasn't really directly established
(25:53):
to be read in a maximalist or minimalist way. Other
parts of the fourteenth Amendment have been litigated to the
end of time. I mean, it is one of the
most litigated parts of the entire Constitution that the Spring
Court heres cases on. But this particular section has very
little litigation associated with it, so we don't really know
what courts would do. But if you read that that
that text, just as you know, sort of a plain text,
(26:15):
then it seems to create a constitutional obligation to pay
the public debt of the United States. And it's one
thing to say, well, you know, we can't pay the
public debt because we've run out of dollars. But we
know you and I, Joe and Tracy and hopefully odd
lots of listeners at this point know that to treasury
creates dollars. In the Federal Reserve creates dollars, and there's
no there's no lack of those dollars there there you
(26:36):
can't run out of them. So that's not that's not
a restraint. What what then, is preventing the federal government,
or specifically the executive branch and the Treasury, from going
out and doing what the Constitution tells it to do
by preventing people from questioning the debt and just saying,
restraints on issuance of debt to make good on payments
(26:56):
owed by the United States to third parties are I'm constitutional.
The dead ceiling is I'm constitutional, and we're going to
keep issuing debt until to to make payments until someone
tells us to stop. That path is one that is
hard to see from a political a political group that
(27:16):
has been as risk averse as the Biden administration has been.
But I do think you can make a very good
case that in an emergency, a situation where there's a
general default, where you know markets are crashing, where you
know there's there's massive economic disruption, that this is a
good choice to be made, that that that the debt
ceiling is totally self defeating. It's a it's a it
(27:37):
shouldn't exists in the first place. And by the way,
there's a constitutional reading right here. Now. I'm not a
constitutional scholar. I'm not a constitutional lawyer. I'm none of
those things. Um, like jay Z said, you know, I
passed the bar, but I know a little bit. I
know enough to know that this could hypothetically work. But
that's about it. So I don't think I would predict
(27:58):
that the bid administration should or could go out and
do this. But it is interesting to think about how
these powers appear to be given to them by the Constitution,
and that there could be a Supreme Court case settled
based on whether the US has just issued bonds that
are illegal under the Constitution. You know. Again fun, So, okay,
(28:23):
we're not going to have like a coin conversation. But
this does get to the other possibility, which is these
technical workarounds that people believe exists in the law. So
one possibility one of these workarounds could be invoked the
fourteenth Amendment, And it seems pretty clear the history on
that does not seem to be particularly ambiguous about why
(28:44):
it's there, And it's kind of you know, I'm reading
on Congress dot gov inspired by the desire to put
beyond question the obligations for the government issued during the
Civil War, and so like, I don't know, like it
doesn't seem particularly ambiguous, but setting aside the fourteenth, talk
to us about some of these other ideas in the
law to avoid a default. I think the easiest one
(29:05):
to understand and easy by the you know, if you
know a little bit of bond math, The easiest one
to understand is this idea of issuing very high coupon bonds.
So when when we issue a bond, typically what happens
is there's a bullet bond. Is the is the standard
term for what people think of, as you know, for instance,
a treasury bond, where you get a series of payments
(29:26):
over time that are called coupons, that are regular small payments,
and then you get a big payment at the end,
which is called the principle. Right principle is you know,
typically you you pay you you quote the price of
a bond as the percentage of the principal payment that
you will receive at the end. So for instance of
bondus trading at that means you pay now and then
you get the series of coupon payments associated with that
(29:47):
bond and the principal payment at the end, which is
a hundred. When Treasury auctions securities they are sensitive to
they basically want to set the price of those securities
just below one when they're first issued. Um, they don't
want to issue bonds at a premium. And they also
have a serious other constraints, like, for instance, the minimum
increment of coupon. So what they'll do is they'll issue
(30:11):
bonds with a coupon that sets the um the principal
payment um or sorry, sets the auction price just below
a hundred when they when they issue. So, for instance,
they're not going to go out and issue a fifteen
coupon coupon bond when the prevailing yield on treasure securities
is like five percent, right like like like, they're never
going to do that. But that's just like an internal
(30:33):
norm that's not like written in law anywhere. They don't
have a legal obligation to do it that way. If
they wanted to, they could go out and issue a
bond that matures with a principal value of a hundred
and pays coupon payments of a hundred, you know, hundred
per year for the next thirty years. Say so let's say,
for instance, they did this, they said, well, we're gonna
issue what's called a super high coupon bond, and again
(30:55):
this is nonsense territory from a from a pure finance perspective.
But let's say they go out and and that bond
that matures thirty years from now at a phase five,
it will pay a hundred and coupons every year as
opposed to the you know, four percent coupon on the
most recently issue third or bond something like that. So
if you do the bond math on that, if you
if you discount all those cash flows back to present
(31:16):
value at the current prevailing interest rate, what you've got
is an eighteen hundred dollar You receive eighteen hundred dollars
today for the bond maturing at a hundred in the future.
And the reason you get that is because it's got
that long string of payments associated with it, whether the
same size as the as the principal payment. You've basically
issued a zero coupon strip, all in one instrument for
(31:37):
the next thirty years. And you've done that, you're the
impact to the debt ceiling is a hundred, but you
now have another seventeen hundred in your in your pocket
because of those coupon payments. Those coupon payments aren't covered
by the debt sailing their coupon payments not principal payments.
Right that when when Treasury counts debt, they're not counting
the coup the interest costs, they're counting the principal value.
(31:59):
So hundred dollars is I mean, like like it's a
technicality where you can say, well, the coupon isn't principal,
but it's still cash in my pocket now delivered at
a later date that doesn't count against the dead ceiling.
So you know, that would be another technical workaround they
could use. Again, this one is on much less dicey
(32:21):
legal footing. There are lots of reasons why Treasury maybe
want to say we don't want to do this, Um,
we don't have any interest in this, we're not able
to do this whatever. There There could be lots of
reasons for that, but but legally it's it's not quite
as dicey as saying to Congress in the Supreme Court, well,
we're just going to keep issuing Debton. You know, take
your best shot at stopping us. I'm trying to think
what would be a harder sell to the public is that,
(32:41):
you know, issuing a high coupon bond that like gets
you immediate proceeds that are a lot more than the
actual issue once amount, or is it a large novelty coin. Well,
I mean, so I was gonna you know, the novelty coin.
I'm sure you know, well, we know the headlines are
gonna be on that. But you know, at the same time,
I'm I'm imagining Biden is borrowing at a hundred percent
(33:03):
interest rates from China to like the payday loan to
like you know, like the the The headlines could go
in either direction, for sure, Yeah, I mean, but then
you have to explain like like what how it's even
possible to borrow a hundred percent interest rates or or
like what is even happening there? I mean, I do
think both the coin for for all it's downsides tracing.
(33:25):
I know how much you love the coin, but you
know the benefit of both the high coupon bond plan
and the coin plan is that they're weird incantations, you know,
run by technocrats. They're not They're not like a tangible
thing where it's like the U. S Constitution and like
this sort of feeling that the world is going straight.
It's like, oh, well they said the right words and
(33:46):
everything is fixed now. So who cares is is how
people tend to think about this stuff. I think. Whereas
when you're talking about the Supreme Court and the Constitution
and Article um section four of the fourteenth Amendment and
the history and that, people get very arpen arms all
the Constitution, you know whatever. Whereas if it's just like, oh,
well we just said the right words magically to the
bond market and now everything's fine, I think you get
a very different you know, feeling from that politically. But
(34:10):
that's speculation on that part. This is something that's important,
which is that okay, let's say the administration to say,
you know what, the fourteenth Amendment says, the dead sailing
is invalid. We're just going to ignore it and continue
fiscal operations as normal. And then, as you pointed out,
there might be some ambiguity about whether the bonds issued
after that moment are legal, and maybe there would be
(34:30):
get to the Supreme Court. We don't really know what
they were going to say. But to some extent, this
even applies to any other solution as well, including the
high coupon bonds, including the coin, which is that like
someone could sue over the coin, Like no one's gonna
stop it. And if like five out of the nine
Supreme Court justices says you can't issue a hundred year bonds,
like that's clearly in violation to the spirit of the
(34:53):
dead Sailing law. You know, you're still issuing debt at
a time when we're not supposed to issue any more
debt Like the uncertain the exist in almost any of
these scenarios for sure. And you know we set it before,
and I'll say it again, this is all a political question,
a social question, right like that, Like political power means
telling people to do something that they don't want to do.
(35:14):
That is what political power is, right, And whether it's
the Biden administration forcing issuance of new debt, whether it's
the Supreme Court stepping into either validate that or or
or invalidate that. You know, that's the fourteenth a medi scenario,
or whether it's the Biden administrations saying, Okay, we're not
going to make any payments regardless of who doesn't get paid,
or it's prioritization where some people get paid, for instance,
(35:37):
bond holders maybe get paid, but you know, retirees don't
like whatever approach you take to this. At some point
someone is being told you don't get what you want
because you can't stop me, you know, under our system,
right like like you physically can't stop me, or you know,
enough of other political bodies have sided with me so
that you can't get done what's what you want to
get done? And you know this is a like at
(36:00):
the end of the day, the dead ceiling has lots
of interesting financial and economic and analytical things to explore,
but it's always going to come back to being a
political problem. Was created by politicians. It's it's being exacerbated
by politicians, and it will be solved through political means
and nothing else. And you know, I just I'll always
come back to that. I I really in that. From
(36:22):
that perspective, I cannot emphasize enough that that Congress has
created this problem for itself, and if there was justice,
then Congress would lose power in some sense over this,
whether it's the death ceiling is invalidated by the Supreme
Quarter or by the by administration or whatever, or you know,
some other solution. Unfortunately, like the world doesn't work based
on karmic justice, So I don't think we can hope
(36:44):
that oh well, the you know, Congress gets its come
up in but maybe they will. I mean, we'll see.
I mean, it's gonna be an interesting few months here,
to say the least. So the overarching theme of this
(37:09):
conversation is just mass uncertainty, lots of hypothetical shooting out
in every different direction, and no one really knows what's
going to happen when we finally hit that X date,
the drop dead date. But there is something sort of
more immediate, a potential more immediate impact. And I think
we touched on this when we were talking about t
(37:29):
g A balances, this idea of you know, the Treasury
is checking account at the Fed. It does have an
impact on liquidity. So what's going on with the t
g A. You know, if there's more money in there,
if there's less money in there, it can mean different
levels of liquidity for the broader economic system, for companies
that might be due payments from the government. Talk to
(37:51):
us a little bit about the immediate impact of all
this discussion over the debt ceiling on market liquidity and
money harry policy as well. Yeah, so this is kind
of a perverse thing about how the mechanics of of
the t g A being inflated with that sort of
cushion we discussed earlier. It's perverse how this works, because
(38:12):
when the Treasury is building up that cushion, they are
withdrawing aggurate liquidity from the private sector. Treasury is withdrawing
liquidity from the private sector because that increase in t
g A balances is being funded by some combination of
higher debt and you know, higher tax as relative depending
it's debt, right, the Treasury is issuing more bills and
(38:33):
more notes and bonds than they technically need for the
specific period in time. That means cash balances are being
dragged out of the private sector and to the Treasury's
cash balance. At the FED, that's a federal reserve liability,
just like a FED fund is, but in the but
the liability that the FED holds in the t g A,
the only asset, the only person who can hold that
as an asset is Treasury, whereas Federal reserve FED funds
(38:56):
are an asset that can be held by the banking
sector and used to match against deposits that are an
asset of the rest of the private sector. So basically
it's like reverse quite right, when this TJ is being
built up, it's it's it's pulling liquidity out of the
private sector and storing it in the t g A.
Then the t as the t J is released, it
does the opposite, right, so it unleashes private sector liquidity
(39:20):
because that liability of the Federal of the Federal Reserve
to the Treasury is being spent down. The payments are
wounding up as assets of the rest of the private
sector or the rest of the world. Basically, everybody but
the federal government funded by Federal Reserve FED funds liabilities
of the of the FED. So it's basically a countercyclical thing,
right Like it's it's as as times are good and
(39:41):
we're you know, go along and t g gets built
up and then we've got worried about that ceiling. But
at the same time, a bunch of liquidity as being unleashed. Now,
the sizes here are not necessarily huge. It sort of
depends on the specific instance. But the size of the
t g A has gotten pretty big relative to the
rest of the Fed's balance sheet as a matter of course.
(40:01):
So prior to the global financial crisis two thousand seven,
two eight kind of range, the TJA was less than
one percent of the FEDS balance sheet. Basically payments in
payments out almost precisely matched each other day to day.
From two eight fifteen, it built up a little bit
because just the scope of federal government spending went up.
There was a lot more issuance of debt with post
crisis deficits that were that slowly sort of declined from
(40:24):
the peaks in two thousand nine. But then when we
get to and treasure says, okay, well we want to
start building up this this cash balance from average six
percent of the Fed's balance sheet UM so it was
below one percent before the goal financial crisis immediately after
is about two after that. After six since q it's
been eleven percent of the FEDS balance sheet. That's a
(40:44):
huge percentage of the FEDS balance sheet, and it swings
around quite a lot, unlike, for instance, the q AST
purchase portfolio. So basically you've got this complicating factor that
has nothing to do with the FEDS monetary policy UM
setting that the FEDS, the FED is not changing policy
based on treasury cash management, and yet it's got this
this sort of impact on aggregate private sector liquidity, both
(41:07):
positive and negative depending on what's going on with the
t g A UH, do you have to account for
so you know, as we see the t g A
spend down over the next few months, it's already underway. Um,
that will have an impact on aggregate private sector liquidity.
That will be kind of sort of counterintuitive. I guess
you could say. Right now, there's about five hundred and
sixty billion in the Treasure General account. That's down from
(41:31):
a peak of almost a trillion in May of last year.
The recent peak, it's it's it's it's sort of trended
lower over the past seven months or so, and that
will continue to trend lower as we go from five
sixty down to zero presumably or near zero at the
X date. All right, I want to ask one more
markets related question, and I think there's this fantasy that
(41:52):
people have, which is that the stock market becomes the
sort of forcing mechanism. The example that everyone would site
is the tarp out. It failed in two thousand and eight,
and the stock market crashed some more, and then they
passed it a couple of days later. It doesn't seem
like that dynamic really holds with the dead ceiling, because
even though there's this potential for catastrophe, on certainty, the
(42:14):
view amongst stocks investors seems to be they always get
it done in the end. Why would I sell my stock, etcetera.
Like can you talk a little bit about, like, as
we get closer, is there any sort of like history
or like the sort of interplay between market volatility and
pressure to just like all right, let's get it past.
There is no doubt that there is a feedback loop
(42:35):
between asset markets and how politicians think in this country.
I mean, using a more recent example from then the
top vote, which I think is a good, good one,
you could look to what happened in the spring of right,
we saw a degree of fiscal stimulus and a degree
of support for households that completely unprecedented in American history
and completely like if you had dreamed up the scenario
(42:57):
where that happens, even if you had you know, no
one about COVID coming, and you had said, okay, well,
then you're going to see this public sector response to that,
I don't think anyone would have believed you. They just said, no,
there's no way that the Republican Congress will will do that.
There's no way that there are no Republicans and Congress
will okay that, There's no way that I'll get through
filibusters and all that, and it absolutely did, and it
(43:18):
did so immediately because asset markets were in free fault
right there. There is a lot more feedback to political
economy in this country and to political out comes in
this country from the stock market then from the unplaying right.
That is just how things work. I'm not defending that,
it's just the reality. So I do think that if
we if we see stock markets start to false you know, measurably,
(43:40):
you know, like like big volatility, big downside in the
months or weeks leading up to the sort of X
state as it sort of becomes more clear, then you
will definitely seem a lot of pressure on politicians to
to just just raise the dang thing, you know, have
your fights about something else. Whether that comes from people
within the respective ideological goals of each party, whether that
(44:01):
comes from the public as a whole, it's unclear, but
either way there will be significant pressure. If, however, stock
markets say, well, you know, like they'll figure it out
and event you know, maybe there there'll be a default,
but like they'll pay those back eventually, and people be
commented and like area with plenty of people that are
willing to pick up an extra twenty five basis points
in a Treasury bill to hold it for a few
months while they figure out this, this this out and
(44:22):
it'll be fine, and so we can just sort of
look past that. If if that happens, that's a recipe
for a much more protracted fight and a much longer
time past the X date with you know, uncertainty going on. Now.
My view would be that if you if you get
to the X date, even if you have prioritization, barring
using one of the technical workarounds we discussed, so either
the coin or using high coupon bonds or um just
(44:45):
saying well, this violates the fourteenth Amendment, so we're going
to ignore the death ceiling if you if you you know,
don't have those and you have either prioritization, which Treasury
said isn't possible but could be possible and you're working
through prioritization, or if you're just doing a general default,
We're we're not paying any payments until the dead ceilings race,
because that's that's what the law tells us to do.
If if I'm the Treasury, okay, either way in either
(45:06):
a prior to a severe prioritization scenario or a general default,
you're going to have large economic impacts from that, right,
Like like that, the volume of outgoing payments that are
not going to show up in the bank accounts of
people that want to spend them, whether those are businesses
whether their individuals, is going to be really big. Social
Security is a really good example. Like if you start
paying Social Security, the entire economy grants to a halt
(45:27):
about a month. There's just not it's it's just such
a huge cash flow for such a large percentagers of
population that you can't So eventually there will be a
feedback to asset markets. This will not last forever where
it's just kind of the new normal that the US
is permanently you know, has the destiny in place, and
you know, only making some outgoing payments. Eventually the economy
starts to collapse, the stock market starts to collapse, and
(45:48):
you you know, you see and another interesting thing, just
to work it back to the Fed. An interesting thing
to think about it is if the economy is collapsing
because all these payments aren't going out and the stock
market is in free fault us, the FED step in
to say, okay, well we're going to cut rates now.
Because the economies and free fall because of what's going
on with the dead sailing or do they say not
our problem? I don't know. I don't have a good
(46:10):
answer for that. I don't I don't think a good
answer exists, but it's something interesting to think about. It
feels like this is one of those topics where there
just aren't a lot of good answers. But George did
a good job. Yeah, you did a great job. There's
a lot of uncertainty and hypotheticals as we've been talking about.
It's not an easy thing to sort of lay out
all the different options and what might happen depending on
what's pursued. But George, it was great having you on.
(46:32):
You did a great job. Thank you so much. Yeah,
thanks for having me on. I mean I can stick
around for another three hours and we can get all
the different hypotheticals if you want. All right, now our
to the coin conversation. Okay, I'm thanks man, let's go.
Thanks for having me on, George. Thanks George. Joe. There's
(47:03):
a lot to unpack from that conversation. I agree, But
George did like a great job, Like you know, there
is a lot of uncertainty. I guess because it's something
that had been lodged in my mind. But like, I'm
glad he brought up that question of like the software
element of defaulted debt, because it's just something like I
want like people like you know, like we don't talk
about debt in those terms. It seems totally like a
(47:25):
Y two K thing, as you mentioned, where people just
would not expect US treasuries to default. And anyway, why
would you prepare for such a scenario, because if that
were to happen, then it would be the collapse of
the financial system as we know it. But yet here
we are, you know, after two thousand eleven, after having
a very similar conversation. The other thing that's stuck out
(47:47):
in my mind was George's point about, you know, ultimately
this is a political process and it plays out in debt.
But the reason it plays out in the debt market
is because debt is inherently, I think, so tied up
with questions of morality and justice, and it's so easy
(48:07):
to build a political narrative on top of something that
is ultimately about who owes what to who and why? Absolutely,
And you know, I think that's why it's really notable
that this was written into the constitution, and we run
into the constitution after the Civil War. And what we
did have that coin conversation was with Roman Grande. He
(48:28):
talked about this as well, which is that like this
fear that in the pursuit of the Civil War that
southern representative representatives from the formerly confederate state would try
to induce a default because it's like, oh, we don't
want to pay the debts of the northern government that
fought a war against does and so they did, like
they this is like, you know, it gets to like
(48:50):
deep constitutional questions and it continues to play out over
and over again in different forms, the political weaponization of debt.
It seems to be happening more often because I think
people have realized that it is an effective pressure point.
As George laid out well on that happy note. Shall
we leave it there, Let's leave it there. Okay. This
has been another episode of the Odd Thoughts podcast. I'm
(49:11):
Tracy Alloway. You can follow me on Twitter at Tracy
Alloway and I'm Joe Why Wasn't Though. You can follow
me on Twitter at the Stalwart. George doesn't really tweet anymore,
but maybe he'll come back one day, so I'll plug
it anyway. His handle is at Perks. Follow our producer
Carmen Rodriguez at Carmen Armand and Dash Bennett at dashbot.
And check out all of our podcasts at Bloomberg. Under
(49:33):
the handle at podcasts and some more odd Lots content.
Go to Bloomberg dot com slash odd Lots when we
push the transcripts. We have a blog, a weekly newsletter
that goes out every Friday. Go there, sign up. Thanks
for listening. See to
Hosts And Creators
Joe Weisenthal
Tracy Alloway
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