US Policy Outlook: Non-Hyperbolic Version
It is widely recognized that the agreement to mitigate the fiscal cliff neither puts the US on a sustainable fiscal path nor lifts much policy uncertainty. At the same time, minutes from the latest FOMC meeting showed that several members anticipate ending QE3+ before the end of the year, seemed to cloud the outlook.
Seeking to avoid partisanship of the heated debates, we offer the following overview of the outlook for US policy, free of hyperbole.
The federal government is already bumping against the debt ceiling. This is the limit on borrowing that Congress has set, though it has already approved the spending. The Treasury Department has already indicated that it is resorting to unorthodox measures that can last a few weeks.
It was under such fight between a Democrat President and Republican-controlled House of Representatives that led to the closure of the government twice in 1995. Some Democrats are encouraging Obama to challenge the constitutionality of the debt ceiling legislation.
The gist of the argument is that the 14th Amendment (to the Constitution) states that the "validity of the public debt of the US, authorized by law...shall not be questioned." The claim is that the debt ceiling raises doubts over the sanctity of US financial obligations. It is, as one pundit put it, like eating a breakfast at a restaurant and then balking when the bill comes. Obama has indicated no intention of challenging the validity of the debt ceiling.
Beginning in the blogosphere seemingly as a joke, the idea that the Treasury Department can take advantage in a loophole to bypass the debt ceiling has captured the imagination of many. The idea here is that the Treasury Dept is free to create platinum coins of any denomination. It could "create" a $1 trillion platinum coin and retire the same amount of existing debt.
Despite the yards of commentary devoted to this idea, it is a non-starter for a numerous reasons. Suffice it is to point to two here. First, if Obama does not want to challenge the constitutionality of the debt ceiling, he is most unlikely to embrace such a gimmick. Second, there is simply nowhere near enough platinum. Reports suggest that only 16 tons of platinum have ever been mined. Near current prices, $1 trillion would require nearly 18,000 tones of platinum.
Around the time that the debt ceiling will have to be addressed, the US will face additional pressure to act. The resolution of the fiscal cliff included delaying the spending cuts until the start of March. The sequester called for $110 bln in spending cuts, evenly divided between defense and non-defense sectors. Social Security and Medicaid spending were not included.
At the end of March, the existing budget appropriation authority expires. This is the authority Congress grants that allows the government to spend money on anything but essential services. This is Congress' ultimate power over the executive branch. It controls the purse strings.
Separately, the debt ceiling, the spending cuts, and expiration of the appropriation authority could see a fierce fight, but together, they may make the fiscal cliff negotiations seem like a tea party.
It is ironic that the minutes from the FOMC meeting at which it decided to more than double the size of its outright asset purchases (to $85 bln a month from $40 bln) and adopt macro-economic guidance that suggests interest rates will not be raised in for more than two more years, some observers see signs of an early end QE. Moreover, the new configuration of the votes on the FOMC, with the annual rotation of regional presidents, gives it a slightly more dovish cast.
A Reuters survey of primary dealers found that 9 of 16 (that responded) see QE ending by the end of the year (8 say at the end of the 2013, while 1 said at the end of H1). Six expected QE to carry into 2014 and 1 expects it to continue into H1 16. The median expects the Fed to buy $540 bln of Treasuries this year, which is $45 bln a month (and there is an additional $40 bln of MBS being bought per month as well).
It terms of unemployment, 9 of the 16 expected it not to fall below 6.5% until 2015, 6 see it in 2014 and 1 does not see it happening until 2016.
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