Kick the can down the road

Today, 3 December, is the deadline by which the US was to have raised its debt ceiling. The US has a very poor record when it comes to handling money; if it was an individual or family it would have been evicted years ago.

It has for years always spent more money than it collects in taxes — it has a permanent shortfall, which it covers by borrowing. This debt ceiling farce started in 1917, when the US Congress passed the Second Liberty Bond Act, by which it also established a debt ‘ceiling’ on how much debt the government could run up. But America regularly busts that limit — since 1917, the limit has been raised 102 times. In October 1918, the US launched its Fourth Liberty Bond, with a call date — the date on which the issuer has the right to redeem the bond at par, or a small premium, prior to the state maturity date — of 15 October 1933. The terms of this bond included the statement: “The principal and interest hereof are payable in United States gold coin of the present standard of value”, which was common in both public and private contracts of the time, and was intended to guarantee that bond-holders would not be harmed by a devaluation of the currency.

But when the US Treasury called this fourth bond on 15 April 1934, it defaulted on this term; it refused to redeem the bond in gold; neither did it account for the devaluation of the dollar from $20.67 per troy ounce of gold (the 1918 standard of value) to $35 per ounce. The 21 million or so bond holders therefore lost 139 million troy ounces of gold, or approximately 41% of the bond’s principal, equivalent to $2.866 billion (in 1918 dollars) and $250 billion in 2021 dollars.

The legal basis for the refusal of the US Treasury to redeem in gold was the gold clause resolution dated June 5, 1933. The Supreme Court held this to be unconstitutional under section 4 of the Fourteenth Amendment. But the Treasury got away with this piece of chicanery because President Franklin D. Roosevelt had signed an Executive Order (number 6102) in 1933, which forbade “the hoarding of gold coin, gold bullion, and gold certificates within the continental United States”. So the Supreme Court ruled that the bond-holders’ loss was unquantifiable, and that to repay them in dollars according to the 1918 standard of value would be an “unjustified enrichment”. Not until December 1974 was this ban on holding gold repealed.

The clock ticks loudly

The clock is ticking in the US. Lots of legislation is piling up to be dealt with before the end of 2021. For one thing Congress needs to approve the National Defense Authorization Act, an annual bill to fund the US military. President Joe Biden is also anxious to get his ‘Build Back Better’ Bill, which will plough $1.75 trillion into childhood education, public healthcare and climate policies, passed. Chuck Schumer, the Democratic Senate majority leader, has vowed to get this passed by 25 December.

But perhaps more important (because if it’s not approved it could force a shutdown of many federal services) Congress needs to agree to continue funding the government by raising the debt ceiling. The US national debt is rapidly approaching $29 trillion; that’s around 126% of US gross domestic product (GDP). Some sources put the debt at more than $140 trillion. Janet Yellen, Treasury Secretary, has warned on several occasions that unless Congress agrees to raise the self-imposed debt ceiling the US government risks having what she calls “insufficient remaining resources” after 15 December. Or in less euphemistic language, the government will run out of money to pay wages, bills, and contracts.

That the US government might default would be catastrophic; it would destroy trust in the world’s biggest economy; according to the White House itself, “financial markets would lose faith in the United States, the dollar would weaken, and stocks would fall. The US credit rating would almost certainly be downgraded, and interest rates would broadly rise for many consumer loans, making products like auto loans and mortgages more expensive for families… These and other consequences could trigger a recession and a credit market freeze that could hurt the ability of American companies to operate”. The Bipartisan Policy Center says that “even a short-term default could lead to higher borrowing costs and liquidity concerns for the private sector, increased unemployment, stock market losses, and GDP contraction, further threatening the country’s recovery from the COVID-19 pandemic and recession”.

That’s surely enough to send shivers down the spine of everyone in Congress.

The chair of the US Federal Reserve, Jerome Powell, has often said this year that US inflation is “transitory”; on Tuesday this week he changed his tune and said it “now appears that factors pushing inflation upward will linger well into next year”. With annualised US inflation now above 6%, the US will certainly borrow more, in the certainty that inflation will nibble away at the debt.

We’ve been here before

US journalists are fond of saying that their country has never defaulted on its debts which, as we have seen, is not quite accurate. In 1814, the US Treasury was unable to meet all its obligations, including some interest payments on federal debts at the end of the war with Britain. The US also failed to make timely payments to some small investors in early 1979, and that was seen as a mini-default.

Congress narrowly avoided running the US into a default in August, when it passed a stopgap measure that raised the debt ceiling by $480 billion, to around $28.4 trillion, to enable the country to limp through to December. The Bipartisan Policy Center estimates that the crunch date, i.e. when the US will no longer be able to meet its obligations, in full and on time, will be close to mid-December.

Even the mere threat of a default would produce serious negative ripples in the global economy. And that’s why the whole debate seems somewhat artificial — surely no American legislator would seriously risk the stability of the global economy?

Except that we live in strange times. Leading Republicans have been insisting that Democrats “go it alone” to raise the debt ceiling, by using a complex legislative procedure called reconciliation. In the early 2000s, Republican Congresses routinely used reconciliation to increase the budget deficit. Democrats however are reluctant go down this route, because it’s slow, time-consuming but also because they understandably want to share the guilt around. The most likely outcome is that this can, now the size of a dumpster, will continue to be kicked down the road, and we will be facing this same debt ceiling question in 2022.

Gold for Christmas

That the US Congress is evenly balanced between Republicans and Democrats is clearly a recipe for legislative paralysis. But this speaks to a bigger problem confronting the US — its deep political divisions and the apparently irreconcilable hostility between grass-roots Democrats and Republicans. A year ago the Pew Research Center said of the US “finding common cause… has eluded us”. As inflation has crept back, apparent threats from hostile powers have ratched-up, and new variants of the coronavirus pop out of the woodwork, the healing that many hoped for under the new US President remains elusive. And behind that is an even bigger problem — the sheer scale of US debt. How long can the US carry on piling up this debt? Will buyers of US Treasury bonds, long regarded as one of the safest investments in the global financial markets, continue to buy them ad infinitum? The debt ceiling didn’t even hit $1 trillion until 1982, 30 years ago. The nation isn’t fighting a world war but government is borrowing like it is.

Risks are everywhere. The risk to your hard-earned money is perhaps the least obvious but the most grave. We don’t know where the next major threat to value will come from, but we do know one means of getting protection, one that has proved its resilience throughout history — gold.

At Glint, we make every effort to demonstrate a balanced conversation between gold, crypto and fiat currencies when it comes to purchasing power and, while we strongly believe that gold is the fairest and most reliable currency on the planet, we need to point out that it isn’t 100% risk free. While we have seen a steady increase over time, the value of gold can fall, which means that its purchasing power can also decline.



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