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Upcoming Debt Ceiling Fight Could Get Really Ugly

FORECASTS & TRENDS E-LETTER
by Gary D. Halbert
October 13, 2015

IN THIS ISSUE

1.  Treasury Out of Money November 5 Unless Congress Acts

2.  This Year’s Debt Ceiling Fight Could Be Really Ugly

3.  Is a New Recession Looming Just Around the Corner?

4.  US Recession Estimates Hit 14-Month High Last Week

5.  NEW SPECIAL REPORT:
    Seven Risk Factors That Could Drive the Markets Lower

Treasury Out of Money November 5 Unless Congress Acts

Here we go again – another debt ceiling battle will play out between now and November 5 when the Treasury says it will run out of “extraordinary measures” to fund the government without exceeding the current debt limit of just over $18 trillion. If the debt ceiling is not increased, the US government will default on its debt.

We’ve seen this movie numerous times before, and we all know how it will ultimately end. But what happens between now and November 5 is likely to be mind-racking for the markets. To understand what is about to happen, let’s do a quick refresher course on the debt ceiling.

The debt ceiling is a cap set by Congress on how much the federal government may have in outstanding debt. That limit applies to debt owed to public investors and institutions (ie – anyone who owns US Treasuries), plus debt owed to federal government trust funds such as Social Security, Medicare, etc. Congress has always set some kind of limit on national debt, but the first modern version of it was set in 1917. Today the debt ceiling is $18.113 trillion.

Raising the debt ceiling simply lets the Treasury borrow the money it needs to pay all US bills and other legal obligations in-full and on time. Those bills are for services already performed and entitlement benefits already approved by Congress.

So raising the debt ceiling is more like a license to continue paying what the country owes. And the obligations are incurred because of countless decisions made by lawmakers from both parties over the years.

So, how often has Congress raised the debt ceiling? On average, more than once a year. Since 1940, there have been 95 measures enacted to adjust the debt limit in one way or another. So why is there usually a big fight to raise it? I’ll get to that below.

Sometimes lawmakers have raised the debt ceiling by small amounts, and other times by large amounts. Sometimes they’ve raised it “temporarily” with provisions for it to “snap back” to a lower level at some point. And sometimes they’ve “suspended” it when they can’t agree on raising it outright.

A suspension is a wink-and-nod maneuver that basically lets the Treasury temporarily borrow as needed to pay bills without regard to the debt limit. Then, when the suspension ends, the debt limit automatically resets to the old cap plus whatever the Treasury borrowed during the suspension period.

We’re actually in a debt ceiling suspension right now. The debt limit was suspended back in March when we hit the statutory limit. Ever since, the Treasury has used special accounting maneuvers - perfectly legal ones - to keep paying all the country’s bills without breaching the ceiling. But these extraordinary measures will be exhausted on November 5, according to the Treasury.

Debt Ceiling Increases

The next question is whether the debt ceiling fight threatens to shut down the government. The answer is no. Congress recently passed a continuing resolution to fund the government through December 11. However, the debt limit bout could get lumped in with that other fight Congress will be having this month over spending – and the spending battle could result in a government shutdown.

Normally by October 1, the start of Uncle Sam’s 2016 fiscal year, Congress has passed bills that authorize federal spending in order to keep the government open.  And to their credit Republicans in the House and Senate did pass the first joint budget resolution since 2009 in early May; however, President Obama roundly criticized it and refused to sign it (pocket veto). So now we are at October 13 and we still don’t have a federal budget for FY2016.

Some Republicans are threatening to make that difficult unless lawmakers defund Planned Parenthood because of a controversy over how the group handles fetal tissue after an abortion. That’s on top of disagreements lawmakers will have over adhering to previously adopted spending caps – known as “sequestration” – but both are topics for another time.

This Year’s Debt Ceiling Fight Could Be Really Ugly

Last week’s scare over a possible government shutdown may have been just the warm-up act for a much bigger threat that could cause the Treasury to default on trillions of dollars of debt. The latest shutdown scare was narrowly averted by a last minute deal in Congress that angered its most conservative members, and some believe prompted House Speaker John Boehner (R-OH) to step down. His presumptive replacement, House Majority Leader Kevin McCarthy (R- CA), abruptly announced Thursday that he would not seek the job for reasons that are still uncertain.

Now, amid the House leadership vacuum, Congress remains paralyzed over a long list of contentious issues, from budget battles to a sweeping new trade deal. But unless Congress acts in the next few weeks to raise the government’s legal borrowing limit, the Treasury will be forced to stop borrowing and paying its bills – potentially including interest on government bonds that have already been sold to investors.

“Congress needs to act or we could be faced with a crisis,” Treasury Secretary Jack Lew said last Thursday at an International Monetary Fund meeting in Lima, Peru. “We have the capacity, but do we have the will?”

Debt

Congress came close to forcing a Treasury default in July 2011, pulling back from the brink at the last minute and agreeing to a compromise. The spectacle cost the US its Triple-A credit rating, even though no payments were actually missed. Now, with the House locked in what could be a protracted leadership battle, the prospect of a self-inflicted financial crisis has increased substantially in the last week.

Some default skeptics have argued that such a default is unlikely because the Treasury would still have enough cash coming in to pay interest on the national debt. But the Treasury has said in the past that it has no legal authority to decide which bills to pay and which to postpone. It’s also not clear whether its payment system could be rejiggered to prioritize some payments over others.

Some default deniers also argued the last time around that President Obama has the power to override Congress and authorize the Treasury to continue borrowing, based on language in the 14th Amendment (“The validity of the public debt of the United States ... shall not be questioned.”) This argument has long been raised but is always slapped down.

And yes, some have even speculated that the Treasury could use its powers to mint coins to create a $1 trillion cash cushion. Unfortunately, there aren't enough gold reserves available to mint such coins, even if it were legal.

The bottom line is that with the current vacuum of leadership in the House of Representatives, no options for the Treasury to print money even temporarily and presumably no Executive Order power for the White House to intervene, this year’s debt ceiling battle could be a nail biter. And the battle will unfold between now and November 5.

Buckle your seatbelts and get ready for a potentially even wilder ride in the markets just ahead.

Is a New Recession Looming Just Around the Corner?

The US economy expanded by a better than expected 3.9% in the 2Q, so why all the speculation of late about a possible recession on the horizon? There are several reasons. First, the strong showing in the 2Q is widely believed to have been a rebound from the weak 1Q growth of just 0.6%, which was largely attributed to the severe winter weather.

Second, China’s economic juggernaut over the last decade has slowed rather dramatically this year, and no one knows how bad it might get over the next year. China’s formerly insatiable demand for commodities and raw materials has plunged, and this is impacting exporters to China around the world, especially emerging market countries in Asia that depend on the Chinese economy.

For these reasons and others, Wall Street is getting increasingly nervous about the prospects for a new recession, both on a global and domestic level.  Slowing global growth has been one of the predominant investing themes in 2015, causing enough turmoil to send both the S&P 500 and the MSCI World Index down 10% or more in late August.

Still, the $73.5 trillion global economy is expected to grow 3.1% in 2015 and 3.6% in 2016, according to the latest International Monetary Fund projections. Those numbers, though, are heading lower and could be revised down even more before all is said and done.

Citigroup economist Willem Buiter looks at the world landscape and sees an economy performing substantially below potential output, which he uses as the general benchmark for the idea of a global recession. With that in mind, he believes the chances of a global recession in 2016 are growing. He recently said:

"We think that the evidence suggests that the global output gap is negative and that the global economy is currently growing at a rate below global potential growth. The (negative) output gap is therefore widening.

From an output gap that was probably quite close to zero fairly recently, continued sub-par global growth is likely to put the global economy back into recession, if indeed the world ever fully emerged of the recession caused by the global financial crisis."

It’s important to keep in mind that US recessions aren’t always a bad thing for stock market investors. In the 12 recessions since World War II, the S&P 500 has gone up six times afterwards and down the other six times. The average has been a decline of 3.1%, followed by an average 12.9% increase six months after the recessions ended and a 15.3% gain a year after, according to S&P Capital IQ.

Yet economists look at global recessions a bit differently than domestic slowdowns. Though there is no strict definition of the word, a country is generally thought to be in “recession” if it registers two consecutive quarters of negative economic growth.

On a global scale, though, the definition is different. Absolute growth less than 3%, or GDP adjusted for market exchange rates below 2%, is generally bad enough to call a recession. By either measure, the world is teetering on the line, with 2015 adjusted growth now estimated at only 2.5% and 2016 at 3%.

US Recession Estimates Hit 14-Month High Last Week

The probability that the world’s largest economy will enter a recession in the next 12 months unexpectedly jumped to 15% this month, its highest level since October 2013, according to economists surveyed earlier this month by Bloomberg. The median estimate had held at only 10% for 13 consecutive months. 

U.S. Recession Estimates

We can look at this a couple of different ways. The first is that the latest jump from 10% for the last almost two years to 15% this month is alarming, and I think we could all agree that global risks of a coming recession in the US have risen in the last year.

On the other hand, while the latest economist survey of recession risks rose to 15% from 10%, this still means that 85% of economists do not believe a recession lies in our near-term future. As always, I caution against putting too much faith in what mainstream economists think, but I always like to bring you the prevailing “wisdom.”  

SPECIAL REPORT:
Seven Risk Factors That Could Drive the Markets Lower

The stock markets plunged lower in late August and most investors are puzzled as to the reason(s) why this happened – and worry whether this pattern is a short-term bump in the road or something more serious.

Back in March and April, I saw the storm clouds gathering on the horizon and warned my readers to reduce their long-only (buy-and-hold) positions in stocks and equity funds. Still, most investors don’t understand why this six year-old bull market seems to have run off the tracks.

For this reason, I have just completed a new Special Report: Seven Risk Factors That Could Drive the Markets Lower. In this report, I discuss in detail the unique combination of risk factors that are weighing on the markets today and why they may continue to do so.

Best of all, I offer advice on what you can do to protect yourself should the latest market downturn continue. If you are looking for some clarity in this crazy market and some advice on how to protect your portfolio, CLICK HERE to download my latest FREE SPECIAL REPORT.

As always, feel free to forward this to family and friends that you think might benefit from it.

Wishing you profits,

Gary D. Halbert

 

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Forecasts & Trends E-Letter is published by ProFutures, Inc. Gary D. Halbert is the president and CEO of ProFutures, Inc. and is the editor of this publication. Information contained herein is taken from sources believed to be reliable but cannot be guaranteed as to its accuracy. Opinions and recommendations herein generally reflect the judgement of Gary D. Halbert (or another named author) and may change at any time without written notice. Market opinions contained herein are intended as general observations and are not intended as specific investment advice. Readers are urged to check with their investment counselors before making any investment decisions. This electronic newsletter does not constitute an offer of sale of any securities. Gary D. Halbert, ProFutures, Inc., and its affiliated companies, its officers, directors and/or employees may or may not have investments in markets or programs mentioned herein. Past results are not necessarily indicative of future results. Reprinting for family or friends is allowed with proper credit. However, republishing (written or electronically) in its entirety or through the use of extensive quotes is prohibited without prior written consent.

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