The Invisible Debt Ceiling

Say what you will about the Tea Party – they know how to get their message across. Some of that message is steeped in fear about changes in the United States that are eroding the “natural order” of white people dominating all political, cultural, social, military and other institutions. When a mixed-race inner city politician was elected as president, it was just too much for many older, white Republicans, who decided that Barack Obama was an illegitimate president whose policies simply had to be opposed.

The Affordable Care Act may well solve some serious problems with the American health care system, but to the Tea Party, Obamacare is illegitimate and must be opposed root and branch because Obama himself is an illegitimate, illegal president. The Tea Party describes Obamacare in the most apocalyptic terms, as if it is going to destroy the country, which only makes sense if you already believe the country is heading to ruin because too many black and brown people are now in positions of power. A basic assumption of many white Republican, Tea Party types is that black and brown people are parasites who live off the government dole (like Food Stamps and Medicaid), and now that they are grabbing on to political power, they are going to institutionalize their lazy lifestyle and force white Americans to support them indefinitely. There is certainly a racist overtone to this assumption.

While it is true that there has been an explosion in the Dependency Class, with nearly 50 million Americans now receiving food stamps, overwhelmingly it is poor white people who are the most dependent on this system. African-Americans and Latinos were never well-represented in the American middle class, which has been decimated by nearly 40 years of stagnant real earnings (earnings taking into account inflation). The fundamental hypocrisy, irony, and psychological disconnect that characterizes Tea Party politics is that the very people who are supporters of the Tea Party are the people most likely to be hurt if governmental props are yanked away from the Dependency Class.

We got very close to this happening during the recent government shutdown. Had the debt ceiling been reached this week, the Treasury would have been forced within one or two weeks to delay Social Security payments. Never mind for a moment a failure to pay interest on the national debt; that undoubtedly would have had enormous financial consequences that would have made the current depression much worse. In term of sheer, immediate political impact, however, failure to pay Social Security would have brought howls of protest to every Tea Party politician, laying bare the hypocrisy of the Tea Party movement. The Tea Party could have easily withered away under the disconnect of what it says it wants, and the reality of getting what it wants.

If President Obama and the Democratic Party were at all Machiavellian, they would have prolonged this crisis beyond the debt ceiling date, to prove a point once and for all: everyone in America is heavily dependent on government largesse. The Tea Party sees the problem as one of race, but establishment politicians in both parties, which includes Mitch McConnell and John Boehner, see the problem as one of maintenance of the political and economic system in the United States. The longer the government shutdown continued, the more difficult it was becoming to maintain that system.

This brings us back to the opening point, that the Tea Party certainly knows how to get a message across, even if it is not the one they expected everyone to learn. Tea Party Republicans go on and on about the evils of the federal budget deficit, now at $17 trillion, without noting the hypocrisy behind their complaints, since it was the Republicans who in 2000 took a $5 trillion deficit and exploded it with tax cuts for the rich, an expansion of Medicare to include drug payments, and wars in Afghanistan and Iraq. None of these activities were financed with tax increases on the American people – it was all financed with debt, left in the lap of Barack Obama, who also inherited a devastating financial and economic collapse that had to be resolved (which it never really was) with even more debt. In point of fact, Barack Obama has presided over the slowest increase in the national debt since Dwight Eisenhower, both of whom came into office after a debt splurge brought on by an explosion in war debts.

And speaking of hypocrisy, the Tea Party will not even countenance the idea of tax increases on anybody. This is probably the fundamental source of political breakdown in Washington – the Democrats can’t begin negotiations with the Republicans if they themselves have removed half of the solution from the discussion. The hypocrisy plays out in the fact that the Republicans want to freeze the debt ceiling so that no further borrowings can take place (beyond roll overs of existing debt), but they don’t want to impose the austerity of tax increases on the people who have money in America – white people, who are the only people who have enough money to help pay the interest on the existing debt and cover the deficit spending that has already been baked in by Congressional initiatives and through inflation. But without the ability to raise taxes on white people (and by this we mean in particular on the 1% super-wealthy, as well as on corporations controlled by white people), the U.S. has no choice but to increase the debt ceiling automatically, if only to meet its interest payments on the deficit.

Several politicians were forced to state this ugly fact: additional debt must be issued in order to pay interest on existing debt. This is what is known in policy terms as a Minsky moment, after the economist Hyman Minsky, who first described the collapse of asset values and concomitant deflation which occurs when over-leveraged economies reach a point when no more borrowing can take place. The first wave of a deflationary collapse in asset values occurred in 2007 when the housing bubble in the U.S. burst. The second wave is soon to be upon us, because what the Tea Party has made obvious, and forced the politicians to admit, is that the Ponzi scheme being run by the government is set to collapse. Ponzi schemes, which are often found in the over-leveraged crises described by Hyman Minsky, require an ever-increasing pool of new investors because this fresh money is used to pay returns to existing investors. The essential fraud behind a Ponzi scheme is that new investors believe they are making an investment – that their money is put to some productive use such as investing in a plant or product that will be very profitable. Instead, the Ponzi scheme uses the new investment money for consumption, not for investment, so you often see the person behind the scheme living in a mansion and driving an expensive car (or these days owning an expensive private airplane).

When a government has to borrow in order to pay interest on its debt, one of two things has happened. Either not enough taxes are being taken in to pay the interest, or if they are, the government does not want to cut back its spending elsewhere to divert all of its tax revenue to ensuring that interest payments are met. It is the latter circumstance which was evident during the government shutdown. The U.S. Treasury said its systems could not be reconfigured to ensure that every coupon owner received interest when due. That may be true, but on the other hand even now that the crisis is over the Treasury is not putting through a rush system project to fix this problem. In fact, the Republicans are insisting that it not fix this problem, so the reality is the U.S. does not want to cut back spending in areas like defense, nor will it tax the wealthy or corporations in order to meet its interest obligations.

Those who own Treasuries are taking note. Nearly 50% of all Treasuries are owned by foreigners, of which China and Japan have by far the biggest holdings (around $1.1 trillion each). It has been at least a year now since either of these countries have increased their holdings, and in the recent shutdown China stated loudly and clearly that it was unhappy with the spectacle of the United States threatening to default on its bonds. In general, China has been pushing for the global economy to move away from the dollar as its reserve currency and Treasuries as the liquidity asset of choice. Treasuries are usually called a risk-free instrument, and Treasury interest rates are the risk-free rate from which all other international financial instruments are compared and priced. This is exactly the situation China wants to scuttle – reliance on what it sees as an unreliable debtor setting the risk-free rate.

Judging by how short term Treasury interest rates responded, China is not alone in its worry. One of the largest mutual funds, Fidelity, admitted it was reducing its Treasury bill holdings because of the risk of default. Citibank said it virtually eliminated all Treasury bills from its portfolio. During the shutdown, Treasury bill interest rates skyrocketed, which is a relative term considering that the rates were close to zero under the Fed’s Zero Interest Rate Policy. Still, a move from 0% to 0.30% represents a significant valuation loss for investors in Treasury bills. More to the point, since the Treasury has been moving much of its borrowing into the two year and lower maturities, because the Fed is conveniently keeping interest rates in that range close to zero, even a 30 basis point move up in yields cost the United States about $50 billion annually in higher interest payments. On the further end of the spectrum, interest rates have gone up nearly 100 basis points (a full 1.0% nominal rate increase), and if that were to happen across all maturities, the U.S. would have to pay $170 billion more in interest every year.

The rise in long term rates occurred in May, when Ben Bernanke gave a slight hint that the Fed was going to begin reducing its purchase of Treasuries under its Quantitative Easing program. The reason rates moved up so much in response is because the Fed is buying up to 80% of all newly issued government paper. In a sense, it has to, since China and Japan are no longer increasing their holdings, and since there are no new buyers to be found in the market.

That means we’ve had two Minsky moments, the first in May at a suggestion that the Fed wasn’t going to continue to prop up the Treasury market and keep rates suppressed, and the second in October when the government shutdown revealed not just the possibility of a default on U.S. debt, but the reality that the U.S. has to borrow larger and larger amounts just to pay interest on its debt. You begin to see what Hyman Minsky was talking about. There comes a point when an over-indebted country becomes trapped with too much debt, and the whole debt system collapses in a deflationary crumble.

The United States is showing clear evidence it has reached a limit on its debt outstanding. China, Japan, and the rest of the world are no longer buyers, especially now that the country appears to have crazily attempted to default on its debt. The Federal Reserve has stepped in as a buyer of last resort under its Quantitative Easing program, which it pretends is designed to boost the economy, reduce unemployment, and avoid inflation. This is all a fiction: the program is really designed to allow the U.S. to continue to issue paper to pay interest on its debt and keep fundamental government programs, including entitlements, functioning. But now the Fed is trapped as well. Even saying it wants to reduce Quantitative Easing scares the market into dumping Treasuries and forcing yields higher. With the recent government shutdown, Fed officials like Charles Evans said this week Quantitative Easing must continue without any reduction. One Fed official said he would like to see it increased.

Quantitative Easing is posing a bigger and bigger program for the big banks, because the program sucks up Treasuries and other securities from these banks, and gives them Fed reserves which yield very little. This is how JP Morgan bank got into trouble with its London Whale fiasco – it was trying to find a way to speculate with over $300 billion of reserves it had received from the Fed. It felt it had to speculate to get a decent return, rather than the paltry 0.25% the Fed is paying on reserves. Other big banks have had similar problems with their exploding reserve portfolios.

The Fed, therefore, would like to stop the Quantitative Easing program. It is burdensome to its commercial bank clients. It has helped balloon the Fed balance sheet to $4 trillion by the end of this year, which means that now both the Fed and the Treasury will face enormous losses if interest rates move up substantially in the market. The program has also stirred up speculative juices in the stock market, which has reached record highs even though corporate earnings have weakened substantially in the past few years, and both valuation and sentiment measures are at alarming levels that suggest the market is in a bubble.

The stock market believes it has a green light to buy stocks no matter how high they get, because the Fed will always be there throwing $85 billion a month into the market. Theoretically, this is impossible. In about three years at the current pace of buying, the Fed would own 100% of the Treasury market. There wouldn’t be a Treasury market, in other words. This might be the solution to the Chinese worry, but it carries enormous risks for the global economy if in so short a period of time the Treasury market were to vanish. This market is the source of financial liquidity for the global economy; Treasuries are the easiest securities to buy and sell (at least at the moment), and they therefore serve as collateral for an untold number of financial transactions. They are the backstop collateral, for example, for all derivatives transactions, which dwarf in notional size the GDP of the United States. Already the major banks involved in derivatives are complaining to the Fed about the scarcity of Treasury collateral, and collateral prices are beginning to reflect this scarcity.

This is just another way in which the Fed is trapped: it cannot continue buying Treasuries from the market without eventually closing down the global financial system, perhaps causing a systemic crisis and deflationary crash in the process. But there you have a Minsky moment again – yet another possibility for a deflationary crash if the Fed and the Treasury continue on their current path. These moments are mounting rapidly, and the next likely one to occur will be in the stock market, which is already in a bubble and highly susceptible to a deflationary crash.

Everywhere you turn, you can see the potential for a deflationary crash. There is some thinking in Tea Party circles that a deflationary crash is just what the doctor ordered, to cleanse the system of debt and reset price levels much lower to match up with income. Maybe they are right, or maybe they sense what is beginning to appear to be inevitable. Certainly the government shutdown has exposed the excruciatingly difficult decisions policy makers in Congress, at the White House, and at the Fed are now facing. There is no place to turn that doesn’t have serious economic costs involved, because it is getting harder and harder for these policy makers to avoid the hard economic landing that is going to take place when everyone finally realizes that the legal debt ceiling set by Congress isn’t what we should all be worried about – it is the invisible debt ceiling set by the market that will one day appear in front of us out of nowhere, and no act of Congress will be able to increase it.

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Comments

I'd blame Obama in here

Pushing big business foreign cheap labor agendas under immigration reform is going to seriously harm the U.S. worker even further and more to the point, the issue should be jobs, revenue, jobs, revenue, jobs on all of their plates and it is the one thing that is not the central issue in D.C.

By promoting corporate written agendas is assuredly one reason the Tea Party could even get a foot hold.

I think claiming it is "race" is ridiculous. Obama is half while and he is way more green as in Harvard, insider boy's club corporate representative than any other color.

But it seems to me the Tea party is some manufactured public relations/marketing agenda. Huge money, such as the Koch Brothers is behind it and is using people's ignorance, fears and proclivity towards rage to push their own truly crazy agendas from these billionaires financing the "movement".

It's astounding how well these techniques work to cause a public froth, we have examples from Nazis to the 2008 Obama campaign running these propaganda techniques and "Triumph of the Will" marketing tactics to get people to believe.

Facts, statistics, accuracy, understanding how debt even works goes out the window with this and it's frightening.

It shows the lack of education in society, where some crazy people can just get on the "pulpit" and "preach to the people" and they will "believe" up is down and black is white. Religious fervor where Satan is the government abounds from these Koch Brothers paid preachers.

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Minsky would disagree

Numarian said "When a government has to borrow in order to pay interest on its debt, one of two things has happened."

-- US law REQUIRES the Treasury to sell bonds equal to the budget deficit. If that law were repealed, there would be no need to sell bonds other than as one means (but not the only means) to control interest rates.

-- bond sales serve to drain excess bank reserves. If not drained, interest rates would fall to zero. So bond sales are a tool to control interest rates (alternatively, the Fed can set an interest rate on bank reserves).

-- the US government spends by marking up bank accounts at the Federal Reserve. It does not have to borrow to spend, except for the legal requirement to sell bonds.

-- if Congress allowed it, we could pay off the National Debt tomorrow, simply by marking up accounts at the Federal Reserve. Alternatively, existing law allows the Treasury to mint high value Platinum Coins that could be used to pay off the national debt. Note that paying off the debt would be deflationary, not inflationary, because it would remove interest income from the economy.

-- the reason the Fed buys bonds is to control interest rates. If rates go up, it's because the Fed wanted them to go up. If rates go down, it's because the Fed wanted rates to go down. The market does not control interest rates -- the market cannot outbid the Fed because the Fed has infinitely deep pockets.

--I encourage you to read about Functional Finance (Abba Lerner), now days embraced by MMT (Warren Mosler).

--Minsky's instability theory concerned PRIVATE debt bubbles, not the debt of a sovereign government. Private sector bubbles eventually burst because the private sector can't print money. But Uncle Sam can print money, so there is no danger of the US defaulting unless it chooses to default.

-- there is no danger of being unable to sell Treasury bonds. Put yourself in a bank's shoes -- you have excess reserves. You can either 1) do nothing with the reserves or 2) earn interest on the excess reserves by buying Treasury bonds. It's a no brainer.

-- Ditto for China. When we import stuff from China, we pay them in dollars, not in yen. China can either 1) use those dollars for toilet paper or 2) use the dollars to buy American stuff or 3) buy Treasury bonds and earn interest. Whichever they choose, it's all good for us.

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Debt recycling

This is only a "what if" but what if instead of leaving a ton of debt to the kids and grandkids, the interest on the debt was paid into the savings accounts of the kids and grandkids, instead if going out the door to the bank of China or any foreign entity that only buys T-bills as part of the process of currency manipulation to devalue their own currency to prop up their export market into the U.S. and trash our industrial base, tax base and labor market. Is having the world's reserve currency a blessing or a curse? Would it tend to turn the owner country into the world's biggest trade deficit black hole and biggest job loser? Are the foreign buyers of T-bills really interested in the wonderful stinking interest rate or something else?

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bipartisan sabotage

The next order of business in Congress is to pursue bipartisan agreement - yuck - on how to widen the trade deficit - fast track the top secret TPP trade deal with no debate, then we find out what's in it; then flood the labor market with foreign guestworkers on demand for every special interest. This is how our government creates jobs for us, by global labor arbitraging us against the world?

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Corporations win the Debt Ceiling/Shutdown Showdown

We're in such trouble for that was one good thing the Tea party did stop, not that they would enact anything in worker's favor, but at least they did stop the onslaught corporate agenda now planning to be pushed through the legislative pike. We're in big trouble as all of these things are going to fry U.S. workers.

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Corporations win the Debt Ceiling/Shutdown Showdown

Well Numarian and his Cronies, Democrats, will always have the Tea Party or the Republicans to Blame. 5yrs into this Mess now taking on even Bigger Mess ACA, and there still Blaming anyone & everyone but themselves. What Happened to the Buck Stops here.

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