Crises? What crises?
Debt sealing….
“You keep me running round and round,
Well that's alright with me,
Nothing, nothing, nothing's gonna
Step in my way.
Living on the ceiling,
No more room down there.” – Living On the Ceiling – Blancmange (1982) [1]
This is based on a client note distributed in the final days of this year’s latest instalment of the the US Debt Ceiling melodrama. At the time we expressed hope that this year’s act would ‘successfully progress to this year’s resolution’. We now realise that we should have been careful what we wished for as there are many reasons to suspect that the fake cure might be even worse than the utterly confected disease. We’ll be sending out notes to explain that in the coming weeks.
However, the questions still remain to be answered - what is this annual political pantomime? And why do American politicians cause world markets to hold their breath every year?
From the adoption of the Constitution until 1917, US legislation did not include any kind of omnibus limit on debt. Each item of spending, via debt issuance or direct borrowing required a congressional resolution. Having to identify (and obtain approval for) which items and in which amounts borrowing could be raised and disbursed was a cumbersome process. This became more challenging as the US economy grew bigger and more complex. It also became a greater issue during the so-called ‘rider wars’[2] of the late nineteenth century when a constitutional stand off had developed between Republican President Rutherford Hayes [3] and a hostile Democrat congress. This all came to a head following the creation of the Federal Reserve System. This latest, and still enduring, attempt to create a national bank was a response to the early twentieth century banking crises. These included the Knickerbocker Panic of 1907. The need to create overall funding arrangements was also made even more necessary by the additional funding required to finance American participation in the later stages of World War I.
The statutory debt limit (debt ceiling) was created under the Liberty Bond Act of 1917. It has been in place ever since, as an overall constraint on debt creation. Raised 78 times since then, it stands, at the time of writing, at $31.4 trillion. It is one of only two such limitations (Denmark being the other).[4]
The debt ceiling is also a complete anachronism and does a significant amount of harm.
Since 1976, there have been 22 shutdowns of federal government due to a lack of federal budget, 2 technical defaults and downgrades of US credit ratings or outlook. The risk of a full default, although unknown territory, is considered potentially catastrophic. In 2010, the standoff between the Obama administration and the Republican house majority prompted a fall of almost 20% in US stock indices. In 2013, the shutdown also led to furloughs of government employees and non-payment of retirement entitlements to retired public sector workers. The Republican Party, which was held to be primarily responsible, saw its approval ratings plummet from 38% to 28%.
Moreover, the debt ceiling also does no good.
Quite aside from the fact that, if it is intended to somehow keep US borrowing in check, then it’s not doing a great job[5], it promotes fundamental misunderstanding of the role of governments in money creation. Stephanie Kelton has explained that a country’s ‘debt’ is really just another form of currency; - just a form which, unlike notes and coin happens to bear interest. There are reasons why it could make more sense for Uncle Sam (and other countries) to simply issue currency and stop issuing ‘debt’.[6] instruments. This at least would remove the understandable, if completely fallacious, reaction of looking at sovereign deb(i)t as though it is debt in the same way that households or businesses have debts. It really isn’t. For the simple reason that countries can issue currency whereas households or businesses generally can’t. At least, not without running the risk of imprisonment for counterfeiting. Arguments that if we ‘print money’ will debase currencies or lead to inflation are based on the same outdated understanding that leads countries to continue to issue government ‘debt’. These understandings are relics from the gold standard era – if governments didn’t have enough gold reserves to issue currency, they would borrow instead. However, that era ended in 1971, when President Nixon closed the ‘gold window’ by which other currencies were convertible to US Dollars and US Dollars could be converted to gold. In an age of fiat currencies, the idea that governments actually need to borrow is a quaint, outmoded notion.[7] Governments can issue as much currency as they choose – the only constraint on that is whether it will cause inflation. This really depends on how much currency is issued, over what timescale and to whom. The first COVID relief payments to American nationals during the pandemic do not appear to have been inflationary. The final one does. This is largely because there were enough people still restricted in terms of movement, stuck at home but feeling secure enough from the prior payments to spend, mainly online, and at roughly the same time, their ‘stimmies’ on goods ordered from the likes of Amazon, that the disrupted supply chains for these goods were overwhelmed.[8]
While myths persist about how monetary economics actually works, politicians will be able to avoid being held to account and even when solutions are found each year, these are typically sub-optimal compromises that achieve the worst of multiple worlds. Here in Thailand, or in Canada, there should be a sense of relief that we don’t have a debt ceiling….even if we have to worry about becoming collateral damage to any catastrophe resulting from American politicians’ refusal to move into the post-1971 world.
[1] Blancmange was a talented English new wave pop duo, formed in the late 1970s, whose chief claim to fame is that half of them used to play in the same football team as the author of this article………
[2] The habit of adding related, partially related and wholly unrelated, riders to bills had already developed by this stage and surprise, surprise much of the argument (other than relating to Southern ‘Reconstruction’) related to budgetary and spending issues, including the solution of minting coinage to help overcome budgetary constraints!
[3] Whose election in itself was arguably one of the messiest and most disputed until the Al Gore- George W Bush hanging chads fiasco By some quirk of historical fate, the outcome in Florida was disputed in both disputed elections.
[4] Denmark’s limit has never presented the same kind of issues. The Danish limit is much broader brush and Danish politicians are generally much less partisan than their American counterparts. EU member countries have to commit to limit sovereign debt issuance to an annual and overall per centage of economic activity, as measured by Gross Domestic Product, or GDP. Thankfully, this is in the process of being relaxed but not before imposing swingeing austerity on large swathes of Europe, including Greece, Ireland, Portugal, Spain and Italy.
[5] In terms of Dollar amounts, which is the basis of the ceiling, USA is not only the largest but exceeds the next 4 largest added together.
[6] As Bangkok-based author and economist Edward Delzio has pointed out, the correct term should probably be
debit, as this is really just an accounting entry - Delzio, E.J. (2015) The National Debit: How the post-gold Standard
Modern Monetary System Really Works. Indianapolis: Dog Ear Pub.
[7] This has given rise to a movement urging the President (who has executive powers over currency issuance) to require a $1 trillion coin to be minted and to be deposited at the Fed who in turn would have to create an additional $1 trillion of funding. Critics of this fail to recognise that this is inherently a far more reasonable solution than the insane problem that it has been devised to solve.
[8] For a lengthier explanation of how government money creation actually works, and a thorough debunking of many
of the surrounding misconceptions, we’d recommend
https://www.bankofengland.co.uk/quarterly-bulletin/2014/q1/money-creation-in-the-modern-economy,
or Kelton, S. (2021) The deficit myth. Hachette UK Distribution. One major point to note is that economic activity is largely funded by debt. In the fiat era, the biggest problems (Asia 1997, US 2008 or the EuroZone in seeming perpetuity) tend to emanate from excessive private debt, rather than from seemingly high volumes of government deb(i)t. The only alternatives to government spending are reduced economic activity (i.e. stagnation/recession) or increased private debt. Government deb(i)ts can be simply erased – private debts can’t.
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About the Author:
Paul Gambles is licensed by the SEC as both a Securities Fundamental Investment Analyst and an Investment planner.
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