Debt Ceiling Drama
June 2023 - Did you hear that? It was the “big sigh of relief” across America that we won’t default on our national debt and the country won’t be plunged into political and economic chaos. Really? Was the “crisis” we just avoided real, or was it just another political episode in our Washington soap opera? Let’s go back over the past few weeks and put some of the numbers and events into perspective to see what really happened and what it means for us and the markets.
We began when Obama took office with an aligned Congress and a war-chest of fiscal stimulus at his disposal. We had an $800 billion stimulus package and a $1.2 trillion deficit in 2010. The Congressional Budget Office showed a $1.6 trillion deficit in 2011. That is more than three times the pre-financial crisis budget deficit of 2008. Remember, during the economic contraction of the Great Recession, the maximum drawdown in economic output, based on the FED’s quarterly reports, was only $500 billion. Simply put, the emergency fiscal stimulus, and subsequent deficit spending spree was far more than the actual damage to the economy.
Unfortunately, all the stimulus and spending did not produce growth. The economy grew below our average trend rate, with the weakest recovery since World War 2. This becomes a major factor in the divided congress by late 2010. In 2011, the House Republicans pushed back and got a reduction in spending, in exchange for a last-minute debt ceiling increase. This was orchestrated by then Secretary of Treasury Tim Geithner. He put a hard stop date of July 8th, then he moved it to August 2nd. They did a deal on August 2nd. That is hard-core “playing chicken.”
Fast forward to today. President Biden enters office with an economy that had already fully recovered the loss of economic output from the pandemic, which was a $2.1 trillion loss of GDP. He plugged it with the $2.2 trillion Cares Act. GDP was nearly back to peak levels by the end of the fourth quarter of 2020. But, if we include the 2023 budget proposal, we have $5.7 trillion in deficit spending over three years. As a reference point, that is $2.7 trillion more than the pre-crisis deficit spending level of 2019. So, we have $2.7 trillion in excess spending to resolve an economic hole that was already plugged. This is driving inflation. It is producing relatively weak growth after inflation. We have the resulting increase in debt and a rising debt service cost. This policy is not intended to stimulate economic growth, but rather to fulfil a social and economic transformation agenda. This debt ceiling standoff was not about debt levels as much as the budget and future policy.
A short comment on interest rates and the national debt. The United States has more than $31 trillion in national debt, financed with treasury bonds to foreign investors. As we continue to increase that debt at the now higher interest rates, we will not be able to service that debt (pay the interest) unless taxes are increased. As a country, we cannot service our debt once the interest rates on that debt exceed somewhere in the 6.25-6.5% rate. Just something to think about as the players in the soap opera spend our money.
On May 17th, President Biden said “to be clear, this negotiation is about the outline of what the budget will look like, it is not about whether or not we will pay our debts.” McCarthy spoke a half hour later and said, “a deal by Sunday is doable.”
But what about interest rates? The United States has never seen rates go from zero to 5% in a year’s time. That is true. But we have also never seen ten years’ worth of money supply dumped into the economy over a two-year period. The excess new money supply should more than compensate for what is a normal 5% interest rate. The new money supply should have resulted in inflation, and it did; but it should have also resulted in boom-time economic growth. It is possible that we could be looking at a boom in economic growth just as people have been looking for recession.
Although most of the news for the past several weeks has been about the debt ceiling, it has been a fight for a higher budget to fund social and economic changes. Radical amounts of money have been put into our economy, but we have not seen the benefit in growth and higher wages to offset the resulting inflation. But there are some big transformational waves coming. Let’s look at one, Artificial Intelligence (AI).
Seven of the top ten stocks on the S & P 500 are involved in AI. We have seen it hit our computers and smartphones over the past several weeks. Check out “ChatGPT” and more recently Google’s AI. It is amazing to see the possibilities with this technology. One analyst made this comment, “The automobile is to mobility, as AI is to productivity.” Indeed, a productivity boom is coming, and it is needed. Productivity growth is key to improving living standards. This same analyst stated, “Just as the 1920’s were defined by innovation with the automobile and widespread access to electricity, we have the formula here for another roaring 20’s.” Stand by for a lot of updates on AI applications and how they will shape our future. There are some reasons to be cautious about how far this will go and if it should be regulated. Elon Musk recently made some comments about the need for regulation of this technology and the dangers of abuse if not monitored. There are doubtless implications for AI replacing workers in certain industries and sectors of the economy. A primary benefit of AI will be its use in generating corporate profits by applications to perform tasks quicker and cheaper.
As a general theme, summertime is a slowdown for financial markets, but this year may prove to be different. The set of the soap opera is getting rearranged next year, and the cast are gearing up for their roles, hoping to be kept on for the next series. Technology is unfolding that could feed the next wave of economic growth and higher living standards.
New products and innovations to existing technologies are coming soon that will disrupt existing markets.
The FED announced last week that they are “pausing” the rate increases and delaying any further increase until “the data supports further tightening.” The FED meets again July 25-26 and again September 19-20, then the end of October and November 1, and the last meeting of the year is December 12-13. Currently, the consensus is at least one more and probably two more rate increases by the end of the year. FED Chair Jerome Powell made it very clear in his remarks last week that the FED is serious about a 2% inflation rate “over time” and that additional increases may be needed. It seems another way of saying “the devil is in the data.”
One final thought about where we are and where we want to go. I just finished a book that puts our current national status into perspective. The book is “Be Your Future Self Now” by Dr. Benjamin Hardy. I would highly recommend this book to anyone who wants to pursue a path of growth and success. Essentially, the author suggests that to make progress in our personal development and business success, it is important to ask yourself the question, “Where do I want to be and who do I want to be in the future?" This could be a month from now or a decade from now. The trick is to begin thinking and acting like that person now. Be that person, then you become that person. Do things the way your future self would do them, and you will become that person. As a country, we need to do things now that reflect what we want our country to be in the future. If we follow procedures, structure laws, adopt policies and elect officials based on what we want to become, then we will become that country. Just a thought.
We recently made several changes to our portfolios based on current interest rates and the possibility of a recession in the near future. These changes were made to position us beyond a potential recession and to focus on high quality fixed income and growth. The market has had a good recovery since the first of the year, and stock prices are rich. If we do experience a recession, we want to be best positioned for it’s effect on a fully priced stock market.
Thank you for allowing us to be your trusted advisor. Your trust is our most valued asset. If your financial situation has changed, or you would like to reassess your risk tolerance, please contact us. We look forward to visiting with you and answering your questions.