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The End Game For The Debt Ceiling

The End Game For The Debt Ceiling

By Howard Wang of Convoy Investments

The US debt ceiling crisis

Currently there is considerable political…



The End Game For The Debt Ceiling

By Howard Wang of Convoy Investments

The US debt ceiling crisis

Currently there is considerable political tension and bickering surrounding the US debt ceiling, resembling the dinner table dynamics of a financially troubled and debt laden family. Over the past few years, I have frequently discussed the escalating US sovereign debt level due to its growing significance in shaping politics, economics, and markets. Struggles like the ongoing debt ceiling issue are likely to become a regular part of our society.

In this letter, I provide context regarding the current debt ceiling impasse, which I believe will have limited short-term impact. More importantly, I delve into the long-term outlook on US debt, discuss some potential solutions to address this issue, and examine the implications for markets and the economy.

Near-term impact of the debt ceiling

While the current round of debt ceiling talks make for good political theatrics, it is unlikely to have substantial practical ramifications on the economy. In the short term, the market anticipates that the US government will likely resolve this crisis. Market indicators suggest a low 1% per year probability of default on US debt over the next five years, slightly higher than during the 2011 and 2013 debt ceiling crises

Markets expect the debt ceiling to be raised without significant practical consequences. The impasse has had minimal impact on US borrowing costs, which have continued to slowly trend down since the end of last year in line with inflation.

Additionally, the US stock market maintains its upward trajectory in 2023.

The relatively benign outlook is likely due to fact that the underlying economics of the US budget were greatly improved by the pandemic, which allowed the US to secure low financing rates while printing money to generate inflation, and boost GDP growth and federal tax income. However, as indicated by the following chart, this positive trajectory is rapidly deteriorating due to rising interest rates, a return to more normal levels of inflation, and a slowing economy.

This pattern is also evident when considering the total debt level as a percentage of GDP. After the initial spike caused by the Covid-19 pandemic, the ratio steadily declined but is now on the rise once again.

I largely agree with market sentiment that the current debt ceiling does not pose a significant immediate threat. However, I believe we are approaching a critical juncture where mounting debt levels, increasing financing costs, a slowing economy, and an expanding government footprint could compound and create an exponential problem.

What is the end game of continuously increasing the debt ceiling?

As the US has the ability to print its own money, the debt ceiling can be repeatedly raised for the time being. One key metric for assessing the sustainability is the cost of servicing debt as a percentage of the US federal government's income (taxes). This is analogous to examining the monthly payments compared to income when determining whether one can afford a house. Let's consider the rough math:

The current debt stands at approximately 125% of GDP. At the current 4% treasury rate, debt servicing costs would amount to 5% of GDP per year once the 4% cost extends to all maturities, which will take some time.

The federal government collects 15-20% of GDP as tax revenue, a consistent figure since World War II.

This means that 25-33% of federal income would go toward debt servicing, which is high but still manageable. For instance, at the personal level, the recommended threshold for housing mortgage payment is typically 30% of income.

Presently, this ratio is actually a bit lower, at around 20% of federal income. Much of the existing debt carries lower interest rates locked in from the last few decades. However, this ratio will rise rapidly as we retire older, cheaper debt and replace it with more expensive new debt. The following chart illustrates the portion of federal income allocated to debt servicing. We are already experiencing the rapid upward swing.

This ratio would deteriorate further if total debt levels increase or if market financing costs rise. For example, at 200% of GDP and a 4% financing cost, interest payments would consume nearly half of federal income. Alternatively, if interest rates were to suddenly rise faster than our GDP growth rate, the total cost of rolling and raising new debt would increase. Either scenario could initiate a downward spiral toward a debt crisis, where the federal government needs to do substantial borrowing to service existing debt, all the while facing higher cost of financing due to the deteriorating balance sheet.

So, how significant is the debt problem we must address? The current debt ceiling stands at $31.4 trillion. According to projections from the US Congress, we will need to issue an additional $130 trillion over the next 30 years, projected to reach around 200% of GDP.

Issuing and managing $130 trillion in debt will pose the most substantial financial challenge for the next generation of Americans. Debt levels have now reached a point where they significantly impact politics, the economy, and financial markets. Gone are the days when Congress, the Treasury, and the Federal Reserve could operate relatively independently. We are already witnessing conflicts in managing objectives such as inflation, financial stability, recession, and the debt ceiling. These conflicts will only worsen. For instance, I believe the Federal Reserve will gradually shift its focus from managing inflation to assisting the Treasury department in managing national debt, albeit discreetly.

Debt has become pervasive, affecting nearly every aspect of our economy and government. The following chart  provides a rough illustration of the interconnectedness that previously existed as more independent components.

So how do we deal with the debt?

The following are some of the levers that will determine whether we handle the debt issue in a healthy manner
or allow it to spiral out of control. With the exception of the last lever, all the proposed solutions have painful
side effects

1) Maintain higher inflation than interest rates

This approach would increase GDP income faster than interest rate costs, boosting income relative to debt. For example, post-Covid inflation has greatly benefited the US government's budget as prices and income grew far faster than the cost of debt.

However, higher inflation often comes with higher borrowing costs and other economic challenges, as we have recently experienced. Therefore, we cannot rely solely on inflating away the debt. Instead, I expect the Federal Reserve to maintain steady moderate inflation slightly higher than their 2% target, likely around that of 10-year treasury rates (around 3-4%).

2) Decrease the value of the dollar

Lowering the value of the dollar is similar to generating domestic inflation in foreign exchange terms. This approach would enhance US competitiveness, reduce trade deficits, and increase GDP. Following a significant surge during Covid, the dollar has begun to depreciate, and I anticipate that the Federal Reserve will encourage a gradual decline in its value.

On the flip side, it is crucial to manage the dollar carefully since its stability has played a significant role in its status as the reserve currency, affording numerous benefits to the US. Additionally, as the dollar weakens, the US will experience imported inflation, which will gradually erode the average American's standard of living. This cure will not come without painful side effects.

3) Use quantitative easing to keep borrowing costs artificially low

This has the obvious benefit of allowing the US to manage its own borrowing costs and to lock in longer term debt when long rates are appropriately low. Simultaneously, lower interest rates encourage shor-tterm growth, further boosting federal income. This strategy worked exceedingly well in the 2010s.

This strategy enables the US to manage its borrowing costs and secure long-term debt when long-term rates are suitably low. Simultaneously, lower interest rates stimulated short-term growth, further increasing federal income. This approach proved highly effective during the 2010s. However, it is worth noting that since the US government would essentially be purchasing its own bonds, there are limitations to this strategy. After all, the Federal Reserve cannot own the entire market. Since Covid, the Federal Reserve has held approximately 30% of all US debt.

I suspect this figure could be increased if necessary. Nevertheless, this strategy must be employed strategically as there are limitations. Carefully managing the financing costs is crucial because of its significant impact on the future of our federal balance sheet. A mere 1% change in financing rates can drastically alter the trajectory of our budget, as shown below in the projections from the congressional budget office.

4) Increase taxes

Raising taxes on a given size of GDP would augment federal tax income. Historically, the US government has collected roughly 15-20% of GDP as tax revenue since World War II.

Increasing taxes will create economic pain and face much political resistance, but may become necessary if the debt situation becomes dire enough. So we should anticipate potential increases in income taxes, wealth taxes, estate taxes, property taxes, and tariffs.

5) Reduce government spending

Reducing government spending is challenging since, aside from spikes and drops during wartime and times like the Covid pandemic, the size of our government has consistently expanded. As our country ages and programs like Social Security and Medicare/Medicaid become more expensive, we can expect government spending to continue growing.

Implementing any cuts will be painful and face considerable political resistance. However, we may find ourselves with no choice but to tighten our belts, so we should prepare for potential reductions in discretionary spending in the future, along with associated economic pains.

6) Related to above, semi-defaults on certain obligations like social security

I anticipate that we may witness soft defaults on mandatory spending, such as scaling back on Social Security. For instance, the Social Security Trust Fund is projected to deplete within the next ten years due to deficits.

Consequently, the program is anticipated to accumulate massive annual deficits, reaching up to $9 trillion per year by 2090, exacerbating the existing US debt issues.

It is highly likely that the next generation of US retirees will not receive the Social Security benefits promised to them.

7) Increase real GDP

This is by far the most desirable solution, as it entails no downsides. It is also how the US managed to overcome its World War II debts. The success of this approach largely hinges on the US's ability to maintain leadership in cutting-edge fields like AI. The provided chart showcases the long-term evolution of the US stock market as a proxy to the US economy. US stock market capitalization as % of the world experienced continuous growth from 1900 to 1970 as the US emerged as the world superpower after the two World Wars. Subsequently, the rest of the world rebuilt and advanced, with countries like Japan rising to prominence and taking away global share. Since 1990, the US has once again regained global market share, largely on the back of technological advancements.

I remain optimistic about the future of the US economy, primarily due to the massive leverage potential in technology, which tends to be a winner-takes-all industry. The head start and ecosystem that the US has cultivated in fields like AI provide our greatest hope for addressing our government's precarious finances.

I believe that US debt will pose a significant problem requiring a combination of all seven levers to resolve. The more we can rely on the last lever of real economic growth, the less painful the process will be. I believe the US will grapple with substantial debt issues while simultaneously serving as a beacon of global growth and innovation.

From an investment standpoint, I expect high volatility, characterized by both extreme highs and lows. Diversification of currencies and assets will be crucial, especially as central banks are forced to become more prominent players in the market, resulting in more black swan events. However, I believe maintaining exposure to US equities, particularly in technology sectors at reasonable valuations, will be key to long-term success.

Because of my expectation of higher-than-anticipated inflation, I think it is important to hedge against inflation directly through commodities, TIPS (Treasury Inflation-Protected Securities), and a small allocation to gold or cryptocurrencies if you believe in the long-term potential of that asset class. Specifically, switching to TIPS early on is recommended due to its relatively small market size compared to nominal bonds, which I hold a bearish view on in the long term. I believe gone are the days of the traditional 60/40 stock/bond portfolio. You’ll like need a 60/40 portfolio of stocks and inflation hedge assets.

Tyler Durden Sun, 05/21/2023 - 17:30

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Why so sad?

Over the past few years, consumer sentiment has increasingly run far below the level predicted by models based on economic data. The Economist illustrates…



Over the past few years, consumer sentiment has increasingly run far below the level predicted by models based on economic data. The Economist illustrates the issue with a graph:

The Economist attributes the gloomy outlook to the lingering effects of Covid.  I suspect the actual explanation is growing political polarization.  Consider the growing partisan gap in how voters evaluate the economy:

Back in the 1990s, there wasn’t much partisan difference in how voters evaluated the condition of the economy.  This was before the public had come to view people with different points of view as the enemy.  I suspect that the responses to polls were more honest back then.  After 9/11, opinion became more polarized.  After Trump was elected, polarization increased even further.  Today, voters in the two major parties live in completely separate worlds, consuming media that is tailored to fit their prejudices.  Thus it’s not surprising that they have radically divergent views of the world.

Voters seem to rate the economy much more highly when their preferred candidate is in power, perhaps partly due to the mistaken assumption that presidents somehow control inflation and the business cycle.  (A myth that is encouraged by our media.)

Until 2021, the biases of the two parties roughly offset, leaving the overall rating roughly equal to the rating one would expect based solely on the economic data.  This changed after Joe Biden became president.  Unlike with President Obama (who inherited a weak economy), Democratic voters are only lukewarm on the current president. 

In contrast, Republican voters have an extremely negative view of President Biden.  With only lukewarm sentiment from Democrats, there is nothing to offset the extremely low economic rating of Republicans.  This leaves the overall rating for the economy far below the level you’d expect with rising real wages, 3.8% unemployment, and 3.7% inflation.  At one point in 2022, consumer sentiment fell below the lowest reading of the early 1980s, when the economy was in far worse shape.

I don’t believe these consumer sentiment figures represent the actual views of the public.  Consumer spending is still very strong, an indication that people feel pretty good about the economy.  Actions speak louder than words.  I suspect the low reported sentiment is mostly a reflection of GOP voters expressing anger at the current political situation.

My own view is that recent economic policy (since 2017) is quite bad, but the negative effects will show up in future years, at a point where we will need to confront the effects of an out of control federal budget.  If people think the current economy is bad, wait until they see what’s coming down the road in a few years!

PS.  Note to commenters:  If you think the economic model is wrong, you need to explain why it fit the data for the 40-year period from 1980 to 2020.


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Menendez indictment looks bad, but there are defenses he can make

The indictment of Sen. Bob Menendez is full of lurid details – hundreds of thousands of dollars in cash stuffed into clothes among them. Will they tank…




Senate Foreign Relations Committee Chairman, Sen. Bob Menendez, D-N.J., right, and his wife Nadine Arslanian. AP Photo/Susan Walsh, File

Reactions came quickly to the federal indictment on Sept. 22, 2023 of New Jersey’s senior U.S. senator, Democrat Bob Menendez. New Jersey Gov. Phil Murphy joined other state Democrats in urging Menendez to resign, saying “The alleged facts are so serious that they compromise the ability of Senator Menendez to effectively represent the people of our state.”

The indictment charged Menendez, “his wife NADINE MENENDEZ, a/k/a ‘Nadine Arslanian,’ and three New Jersey businessmen, WAEL HANA, a/k/a ‘Will Hana,’ JOSE URIBE, and FRED DAIBES, with participating in a years-long bribery scheme…in exchange for MENENDEZ’s agreement to use his official position to protect and enrich them and to benefit the Government of Egypt.” Menendez said he believed the case would be “successfully resolved once all of the facts are presented,” but he stepped down temporarily as the chairman of the Senate’s influential Committee on Foreign Relations.

The Conversation’s senior politics and democracy editor, Naomi Schalit, interviewed longtime Washington, D.C. lawyer and Penn State Dickinson Law professor Stanley M. Brand, who has served as general counsel for the House of Representatives and is a prominent white-collar defense attorney, and asked him to explain the indictment – and the outlook for Menendez both legally and politically.

What did you think when you first read this indictment?

As an old seafaring pal once told me, “even a thin pancake has two sides.”

Reading the criminal indictment in a case for the first time often produces a startled reaction to the government’s case. But as my over 40 years of experience defending public corruption cases and teaching criminal law has taught me, there are usually issues presented by an indictment that can be challenged by the defense.

In addition, as judges routinely instruct juries in these cases, the indictment is not evidence and the jury may not rely on it to draw any conclusions.

A man in a suit pointing at a poster board with various photos on it.
Damian Williams, U.S. Attorney for the Southern District of New York, speaks during a press conference on Sept. 22, 2023 after announcing the Menendez indictment. Alexi J. Rosenfeld/Getty Images

The average reader will look at the indictment and say “These guys are toast.” But are there ways Menendez can defend himself?

There are a number of complex issues presented by these charges that could be argued by the defense in court.

First, while the indictment charges a conspiracy to commit bribery, it does not charge the substantive crime of bribery itself. This may suggest that the government lacks what it believes is direct evidence of a quid pro quo – “this for that” – between Menendez and the alleged bribers.

There is evidence of conversations and texts that coyly and perhaps purposely avoid explicit acknowledgment of a corrupt agreement, for instance, “On or about January 24, 2022, DAIBES’s Driver exchanged two brief calls with NADINE MENENDEZ. NADINE MENENDEZ then texted DAIBES, writing, ‘Thank you. Christmas in January.’”

The government will argue that this reflects acknowledgment of a connection between official action and delivery of cash to Sen. Menendez, even though it is a less than express statement of the connection.

Speaking in this kind of code may not fully absolve the defendants, but the government must prove the defendants’ intent to carry out a corrupt agreement beyond a reasonable doubt – and juries sometimes want to see more than innuendo before convicting.

The government has also charged a crime calledhonest services fraud” – essentially, a crime involving a public official putting their own financial interest above the public interest in their otherwise honest and faithful performance of their duties.

The alleged failure of Sen. Menendez to list the gifts, as required, on his Senate financial disclosure forms will be cited by prosecutors as evidence of “consciousness of guilt” – an attempt to conceal the transactions.

However, under a recent Supreme Court case involving former Gov. Bob McDonnell of Virginia for similar crimes, the definition of “official acts” under the bribery statute has been narrowly defined to mean only formal decisions or proceedings. That definition does not include less-formal actions like those performed by Sen. Menendez, such as meetings with Egyptian military officials.

The Supreme Court rejected an interpretation of official acts that included arranging meetings with state officials and hosting events at the Governor’s mansion or promoting a private businessman’s products at such events.

When it comes time for the judge to instruct the jury at the end of the trial, Sen. Menendez may well be able to argue that much of what he did not constitute “official acts” and therefore are not illegal under the bribery statute.

This case involves alleged favors done for a foreign country in exchange for money. Does that change this case from simple bribery to something more serious?

The issue of foreign military sales to Egypt may also present a constitutional obstacle to the government.

The indictment specifically cites Sen. Menendez’s role as chairman of the Senate Foreign Relations Committee and actions he took in that role in releasing holds on certain military sales to Egypt and letters to his colleagues on that issue. The Constitution’s Speech or Debate Clause protects members from liability or questioning when undertaking actions within the “legitimate legislative sphere” – which undoubtedly includes these functions.

While this will not likely be a defense to all the allegations, it could require paring the allegations related to this conduct. That would whittle away at a pillar of the government’s attempt to show Sen. Mendendez had committed abuse of office.

In fact, when the government has charged members of Congress with various forms of corruption, courts have rejected any reference to their membership on congressional committees as evidence against them.

Three men in suits, standing in front of a fire engine.
NJ Gov. Phil Murphy, left, seen here in 2018 with fellow Democrats Sens. Robert Menendez and Cory Booker, has called on Menendez to resign. AP Photo/Wayne Parry

How likely is Sen. Mendendez’ ouster from the Senate?

Generally, neither the House nor Senate will move to expel an indicted member before conviction.

There have been rare exceptions, such as when Sen. Harrison “Pete” Williams was indicted in the FBI ABSCAM sting operation from the late 1970s and early 1980s against members of Congress. He resigned in 1982 shortly before an expulsion vote. With current Democratic control of the Senate by a margin of just one seat, Sen. Menendez’ ouster seems unlikely even though the Democratic governor of New Jersey would assuredly appoint a Democrat to fill the vacancy.

“In the history of the United States Congress, it is doubtful there has ever been a corruption allegation of this depth and seriousness,” former New Jersey Sen. Robert Torricelli said. True?

That seems hyperbolic. The Menendez case is just the latest in a long line of corruption cases involving members of Congress.

In the ABSCAM case, seven members of the House and one Senator were all convicted in a bribery scheme. That scheme involved undercover FBI agents dressed up as wealthy Arabs, offering cash to Congressmembers in return for a variety of political favors.

In the Korean Influence Investigation in 1978 – when I served as House Counsel – the House and Department of Justice conducted an extensive investigation of influence peddling by Tongsun Park, a Korean national in which questionnaires were sent to every member of the House relating to acceptance of gifts from Park.

Going all the way back to 1872, there was the Credit Mobilier scandal that involved prominent members of the House and Vice President Schuyler Colfax in a scheme to reward these government officials with shares in the transcontinental railroad company in exchange for their support of funding for the project.

Stanley M. Brand does not work for, consult, own shares in or receive funding from any company or organization that would benefit from this article, and has disclosed no relevant affiliations beyond their academic appointment.

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Von Der Leyen Speech Suggests Russia Dropped Nuke On Hiroshima 

Von Der Leyen Speech Suggests Russia Dropped Nuke On Hiroshima 

Von der Leyen just said what?…

This past Wednesday, President of the European…



Von Der Leyen Speech Suggests Russia Dropped Nuke On Hiroshima 

Von der Leyen just said what?...

This past Wednesday, President of the European Commission Ursula von der Leyen delivered a speech before the 2023 Atlantic Council Awards in New York, where she sounded the alarm over the specter of nuclear war centered on the Russia-Ukraine conflict. But while invoking remembrance of the some 78,000 civilians killed instantly by the atomic bomb dropped on Hiroshima at the end of WWII, she said her warning comes "especially at a time when Russia threatens to use nuclear weapons once again". She  actually framed the atomic atrocity in a way that made it sound like the Russians did it. Watch:

There was not one single acknowledgement in Von der Leyen's speech that it was in fact the United States which incinerated and maimed hundreds of thousands when it dropped no less that two atomic bombs on Japanese cities.

Here were her precise words, according to an Atlantic Council transcript...

You, dear Prime Minister, showed me the meaning of this proverb during the G7 summit in Japan last year. You brought us to your hometown of Hiroshima, the place where you have your roots and which has deeply shaped your life and leadership. Many of your relatives lost their life when the atomic bomb razed Hiroshima to the ground. You have grown up with the stories of the survivors. And you wanted us to listen to the same stories, to face the past, and learn something about the future.

It was a sobering start to the G7, and one that I will not forget, especially at a time when Russia threatens to use nuclear weapons once again. It is heinous. It is dangerous. And in the shadow of Hiroshima, it is unforgivable

The above video of that segment of the speech gives a better idea of the subtle way she closely associated in her rhetoric the words "once again" with the phrase "shadow of Hiroshima" while focusing on what Russia is doing, to make it sound like it was Moscow behind the past atrocities.

Via dpa

Russian media not only picked up on the woefully misleading comments, but the Kremlin issued a formal rebuke of Von der Leyen's speech as well:

In response to von der Leynen's remarks, Russian Foreign Ministry spokeswoman Maria Zakharova accused the European Commission president of making "no mention whatsoever of the US and its executioners who dropped the bombs on populated Japanese cities."

Zakharova responded on social media, arguing that von der Leyen's assertions on Moscow's supposed intentions to employ nuclear weapons "is despicable and dangerous" and "lies."

Some Russian embassies in various parts of the globe also highlighted the speech on social media, denouncing the "empire of lies" and those Western leaders issuing 'shameful' propaganda and historical revisionism.

Tyler Durden Sun, 09/24/2023 - 13:15

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