Guest Post: Debt Ceiling Dilemma: The Foul Choice Facing Investors

Tyler Durden's picture

Submitted by Chris Martenson

Debt Ceiling Dilemma: The Foul Choice Facing Investors

For the record, I still believe that there will not be a breach of the debt ceiling and no overt default for the US. Things will be worked out in the nick of time, like they always are.

However, the media is full of articles wondering about what ‘investors’ might do in response to a US default and/or credit downgrade. What will happen to Treasury prices? Will they go down as investors dump them en masse in response to a credit downgrade forcing interest rates to climb?

It’s a big question and the most likely answer is “No, not really”. Partly because these so-called investors have been well-conditioned to believe that another bailout is always around the corner, but mainly because they have nowhere to go.

The big money is trapped.

For example, imagine that you are in charge of a money market fund with $100 billion under management and your job is to both cover your expenses and assure a return for your depositors and you are heavily invested in US Treasurys. Or imagine that you are in charge of a public pension with $200 billion under management with the same basic concerns of managing expenses and delivering returns and a heavy exposure to US Treasurys but with a much longer time horizon.

In either case, in light of the possibility of a US default what would you do? Where would you put your money right now if you were suddenly of the mind that the $50 billion you had in Treasurys should be placed somewhere else? In reality there are not that many places to quickly move such large sums of money. Further, there might be fiduciary restrictions that limit your investment options to regions, securities types and/or ratings grades or there might be a minimum liquidity requirement for the investment pool.

So let's imagine that you have to make very large and important financial decisions and that you have to put your money to work; it's either an actual fiduciary or operational requirement of yours. An excessive amount of cash is not an option and neither are hard assets such as land, gold or silver. Where would you put it? What realistic options exist?  It turns out there are not that many.

The Treasury market is the largest and most liquid in the world, by far. For many big money funds there really aren’t any realistic options other than the Treasury market, and this present reality will limit the market reaction to any downgrade.

A Foul Choice

With interest rates on 'safe' sovereign debt at or near zero on the short end, and well below the rate of inflation on the long end, safe bonds offer a negative real yield (meaning a yield below the rate of inflation). This is a compounding disaster for everyone but especially for pension funds with their longer time horizons. Worse, we now know sovereign debt can no longer be considered safe (even the US is facing a downgrade threat) - which means that on a risk-adjusted basis, the returns are even more unattractive than the negative real yields on offer.

On the surface, the choice that Bernanke has engineered for investors is between guaranteed losses via the miracle of negative real compounding and taking on more investment risk. But he’s managed to combine both negative returns and risk into a very unattractive investment brew.

Most big money funds have opted to take on more risk rather than suffer such low returns (and who could blame them?) and have done so by going to where the yields happen to be. This means buying up corporate paper and European debt, both of which have far more risk than their nominally more attractive yields would imply.  For individual investors, especially savers and those living on small incomes tied to interest rates, the negative interest rates have been especially difficult if not an outright disaster.

Once again, we can thank Ben Bernanke et al for driving interest rates into punishingly-low territory forcing everyone with a desire or responsibility to save and invest to either lose to inflation or to take on more risk.

Part of the goal behind ultra-low interest rates was to drive money back into the stock market, which the Fed has been specifically and openly targeting in both word and deed.  It is a well known fact that low interest rates are supportive to the stock market and so far that strategy has worked.

On the flip side of this success is the fact that a lot more risk has been forced into the system. When prices are artificially distorted to the upside for stocks or bonds, then it is axiomatic that risk becomes mispriced.

Having to choose between mispriced risk and negative returns is truly a foul choice indeed.

The Deficit Theatre

All of this brings us to the current sad state of affairs now put into high relief by the deficit talks in DC, which more properly should be viewed as political theater rather than a legitimate attempt to square the federal budget up with reality. If the talks were truly legitimate, then on the expense side everything would be on the table, especially and including defense spending and a balanced budget amendment would not be a source of contention but a mutually agreed upon goal.

Instead the Democrats are willing to entertain higher spending cuts in the vicinity of $250 billion per year as long as they can have a debt ceiling increase that would get them safely past the 2012 elections. Conversely, the Republicans as represented by Boehner are ready to concede to relatively meaningless spending cuts in the vicinity of $100 billion per year as long as they can force the debt ceiling to be an issue for the 2012 election cycle:

Mr. Reid, the Senate’s top Democrat, was trying Sunday to cobble together a plan to raise the government’s debt limit by $2.4 trillion through the 2012 election, with spending cuts of about $2.5 trillion. He would seek to avoid cuts to entitlement programs, but it was unclear how those savings would be achieved.

Notably, the plan does not currently contain any new or increased taxes, an approach that many in his caucus would probably balk at.

The contours of Mr. Boehner’s backup plan were far from clear, but it seemed likely to take the form of a two-step process, with a short-term increase in the debt limit along with about $1 trillion in cuts, an amount the Republicans said was sufficient to clear the way for a debt limit increase through year’s end. That would be followed by future cuts guided by a new legislative commission that would consider a broader range of trims, program overhauls and revenue increases.

(Source – NYT) 

Just looking at the proposed levels of deficit reduction, whether it's $1 trillion or $2.5 trillion, neither plan will drop the deficit enough to prevent the US from slipping deeper and deeper into the red. The true drivers of the debate, such as they are, center on political advantage and power. Count us among the unsurprised at this turn of events.

It would be nice - essential even - to have enough information to go on to really assess the true dimensions of the deficit reduction proposals but, even for a committed analyst like myself, there’s just too little detail to make a decent analysis of any of the competing packages.

However, we can be almost certain that their baseline assumptions about GDP and revenue growth that undergird the putative future deficit levels are unrealistic. They always are in these sorts of circumstances, which means the amount of future savings being bandied about are unlikely to be as robust as claimed.

For example, the most recent CBO budget projections (the foundation upon which the deficit reduction proposals are most likely built), assume that over the next 5 years (2011 – 2016) that revenue will grow at a compounded rate of 11.4% per annum(!), expenses by 3.9% and GDP by a whopping 4.95%.

Per year.



These assumptions are just silly. Costs have risen much faster, and revenue and GDP far slower, over the prior five years, and if these pie in the sky projections do not come to pass then all of the deficit numbers will blow out to the upside in those future years.


For example, if we assume that GDP growth is 2.5% per annum instead of nearly 5% (and that revenues are tied to GDP),adn that revenues will therefore 'only' increase by 5% per annum (both completely reasonable assumptions at this stage) then the additional cumulative deficit that will accrue between 2011 and 2016 is $2.7 trillion dollars.

That will completely eliminate all of the projected savings from even the most agressive of the proposals on the table.  Is this unlikely?  No, in fact these are a far more defensible set of assumptions than those currently being put forth by the CBO.

To really make a mockery of the current budget projections, there is absolutely no chance of the government both cutting its share of GDP by 2% per year and having the GDP grow by nearly 5% per year. Implied is a rate of economic growth in the private sector that would be truly extraordinary.  Further, there is no chance of revenues climbing by more than 11% per year over the next five years without an enormous increase in taxes, which neither party is currently proposing.

In short, without knowing the underlying assumptions that are driving the projections, we cannot say much about the proposals themselves. All I can tell you for sure is that for as long as I have been crunching government numbers, taking their rosy projections and cutting them in half has always been a reliable and reasonable starting point.

A Dawning Awareness

What should not be lost on anyone is the degree to which some of the biggest names in the financial world are starting to openly question fiat money and the entire system of debt itself. They’re even doing it on TV, in prime time and on the op-ed pages of the largest newspapers.

Again, by the time we are seeing such open questioning of the very firmament of the entire system, this tells us something about how far along in the narrative we really are. Just a few years ago such talk would have been relegated to the very fringes of the blogosphere.

Here are a few recent examples:

Debt talk damage has already been done

As Washington dithers over raising the nation's debt ceiling, investor confidence is flowing away.

"The issue is not just whether Moody's or Standard and Poor's were to downgrade (U.S. Treasury debt), it's whether the market decides to downgrade," said Rochdale Securities bank analyst Richard Bove.

"If they lose faith in the Congress and the government to, in essence, create a solid security for the buyers of that security, then you get the downgrade," he said.

The sentiment was echoed overseas, where many countries hold U.S. Treasuries as an investment. "An adverse shock in the United States could have serious spillovers on the rest of the world," warned Christine Lagarde, the managing director of the International Monetary Fund.

"We live in a highly interconnected international financial world that is really based upon confidence," said financial services industry lobbyist Paul Equale.

"And without confidence, both domestically and internationally — that the United States is mature enough and has a system that can handle making the big decisions — without that confidence we're going to see things like the dollar becoming less important as the world's reserve currency."

Debt-based fiat money relies on multiple levels of confidence. There has to be confidence that the money will not be over-produced in response to every perceived crisis (oops), that its allocation is justified and fair to all parties when it is placed into circulation (oops, again), and there has to be confidence that the future will be exponentially larger than the past to justify ever-increasing levels of debt (this is the big ‘oops’).

We are drawing ever closer to the recognition that endless growth is simply neither possible nor a reasonable expectation. There are even doubts now that growth as we’ve recently know it will return for one last cameo appearance over the next five to ten years.

With the evaporation of that all-important narrative of growth, everything else becomes immediately suspect, especially money itself.

Sometimes you will hear or read someone exclaim that ever since the slamming of the gold window in 1971 that US dollars are not backed by anything. This is not true, they are backed by debt. Debt is an incredible motivator and assures that the person, entity or country under its yoke will dedicate some portion of their productive efforts towards servicing that debt.

Another Big Round Number (and a Nice Symmetry)

On August 15th 2011 we experience the 40th anniversary of the slamming of the gold window back on the same date in 1971. Perhaps we should all bow our heads and have a silent moment to mark the occasion.

Interestingly, that’s almost exactly the date, give or take a few days, on which the US treasury will run out of money here in 2011:

“We don’t think there will be a default,” Ahrens, head of U.S. rates strategy for UBS in Stamford, Connecticut, said yesterday in a telephone interview. He estimates the Treasury has enough cash to make all payments until Aug. 8-10.


Forty years between a final abandonment of the last vestige of external restraint on money/credit creation and the dawning recognition that the US has simply gone too far, spent too much, and is now in an enormous fiscal predicament.  In the annals of history that's just about right for the lifespan of a purely fiat currency.

Mark the date on your calendars: we’ll certainly be observing the anniversary here at Forty is a big, round number and therefore important.

So what's likely to happen to the dollar and key asset classes in the aftermath of the looming August 2 deadline? In Part II of this report: What Should Happen and What Will Happen we analyze the probable future direction of stocks, bonds, precious metals, commodities, real estate and other assets. Additionally, we assess the odds of a resumption of quantitative easing by the Federal Reserve, and what changes to the picture that will cause when/if it occurs.

Click here to read Part II of this report. (free executive summary, enrollment required to access)

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Hero Protagonist's picture

What happened to the world will end if the Fed isn't buying at the pace of QE2?

baby_BLYTHE's picture

aren't they still scheduled to roll-over 200-300b in maturing securites over the next few months?

If so, once that stops things will get interesting...

Ahmeexnal's picture

"gold or silver" is not an option?

Tell that to CBs all around the globe.

Martenson has no idea who the "big money" really is.

PaperBugsBurn's picture

Exactly... this system has always been a banksters' rigged game of empire. All of these "markets" (rentier class) have always been pawns in a much bigger game. The fiat was and is used to expand and police their empire and not as solid investments..

speaking of solid


Frankie Carbone's picture

Hey bro. Imagine you running a large pension fund like CALPERS. Then imagine trying to move your 200B+ dollar pension fund into the gold/silver markets and see what kind of fallout that you see from it. 


Ten billion or <5%. Sure. 50% or more? Woah. 

You'd be removed from your post in 24 hours for breech of fiduciary responsibility. 

It's not unusual for a CB to move big PM money around. It's a headline if a pension fund does. 

Witness UTexas. I think that was 10B. 

All I'm sayin' is that I don't think it's that easy. The mainstream perception right now still is "not right". The sheep don't know what you know so they'll absolutely flip at such a large move. 

TruthInSunshine's picture
At 12:32 pm est, the fix is in - overt manipulation on an epic scale, bitchez.


Hero Protagonist's picture

It's still a much smaller amount than the original pace and for that everyone was predicting dooms-day scenarios.  

I think the entire economy is a joke, however, the Federal Reserve's influence via QE on the US's ability to float loans I think has been proven wrong by the fact that NOTHING has changed in the auctions since the end of QE2.  

SheepDog-One's picture

'Nothing has changed', yea what about the $200 billion or so that Treasury has helped itself to out of govt pension funds to make it seem like 'nothing has changed'? Where does that money get replaced from?

Hero Protagonist's picture

Good point.  Does that mean that but for the $250 Billion raided by the treasury that Primary Dealers or foreign governments would not have made up the difference in auctions?

SheepDog-One's picture

Well Bernank says that as soon as the debt ceiling is raised, then that money will be replaced, so then any 'deal' is immediately -$200 billion or whatever the actual number is by now. And if flippin bonds for spectacular gains was such an easy sure thing why havent we just been printing and flipping bonds to fully fund ourselves for decades?

Hero Protagonist's picture

My point is that I haven't seen any major change in the auctions since the end of QE2.  Many were saying that there would not be enough interest in the auctions and rates would soar.  They haven't.  It calls into question whether the Fed's QE has any real effect on these auctions.  Now if you look at the equity markets, from a psychological standpoint, QE headlines move the heard...just not in the Treasury Auction market.

IQ 145's picture

 I like the back to basics tone of the post; but without causing huge upset to the "big money", whatever; the long bond contract on the CME could lose a couple of full numbers, or a little more. This contract made a beautiful double top in Setp. and Oct. 2010; and I have considered it a bear market since then. So do, Jim Rogers, Bill Gross, etc. The lack of reaction at present doesn't bother me; I shorted the contract today from 126-08; just because it stuck it's head up. Markets frequently react slowly and then over react. It's a very difficult market; it hops around a lot, but I'm imterpreting the chart as a bearish slide. We'll see what happens.

SheepDog-One's picture

What about the $200 billion or so Treasury has dipped out of govt pension funds and piled into its own treasuries?

ww2vet's picture

what happened was all ugly, nose-picking failure who make up most of zh wrong again again-cant face sucess outside their cell-wishing all the "haves" lose everything so will be on same-0-level


Timmay's picture

Storm the beaches of Normandy or turn the boat around and go home. Those are the choices before us.

Long-John-Silver's picture

<===The nick of time

<===Out of time

Cheesy Pole

RobotTrader's picture



There is no issue with the debt ceiling with the 10-yr. Treasury at 2.96%.  If there was going to be a problem the 10-yr. would be at 5%+ already.

People will feel better owning Uncle Gorilla Notes whether they are AAA-rated or AA-rated.

Still safer than gambling on commodities and especially gold mining stocks.

Even Exxon with $125 billion in quarterly revenues is hated.

The love affair with fixed income continues unabated.

baby_BLYTHE's picture

umm, there is a big problem. People's money is being stolen through inflation.

10-yr is only 2.96% when real inflation is running between 6-9% per annum.

It's the worst situation in the world for people that are fiscally prudent

Long-John-Silver's picture

Just once I'd love to see a movie where the guy in hibernation for a hundred years or so gets awakened.

While he trying to get his life back together he stops by his financial institution to check on his investment

in Treasury bonds. Upon entering his name and pass code security immediately shows up.

He's thinking; Wow! I must have a lot of money in my account. He is taken to a private office and told

that he owes $25,000,000,000,000,000,000 to the government.

Hero Protagonist's picture

Exactly and that's what makes the debt ceiling discussion so maddening. The financial industry through bail-outs and bonuses which both Democrats and Republicans blessed are now talking about fiscal restraint?  Great on the backs of people who actually saved and lived within their means?  It's a horror show.

FeralSerf's picture

That's "only" losing 3 - 6% per year of your capital and presumes that the USTs are really a no risk investment.  Tell that to the Argentines that had all their pensions in pesos 10 yrs. ago.  The ones that could get out of pesos and  domestic investments didn't lose nearly as much.  Some of those even had enough left so they could still eat and enjoy a San Miguel in Barcelona.  Most people weren't able to get out of their domestic investments in pesos though and their retirements weren't as pretty as they planned.  Many lost everything.

Moral: think and plan internationally.

SheepDog-One's picture

Hey MORON, the largest holders of those treasury notes is the treasury itself! DUH!

baby_BLYTHE's picture

1.6 trillion the FED owns needs to be cancelled. Give them the finger and walk.

Central Bankster's picture

To paraphrase the wise Robot Trader:


"Ignore the author who knows nothing, buy Treasuries and sell commodity stocks."

Central Bankster's picture

I take it my junker couldn't detect the sarcasm :O)

slaughterer's picture

No place for big money to run.  They are stuck with Banana Bernankes and Zodiac Timmahs, whether they like it or not.  We all live in Obamica. 

IQ 145's picture

What you say is basically true. However, gambling on commodities produces profits whereas Bonds are instruments of loss, due to inflation. To a great extent, the love affair with fixed income securities does continue abated; this is a give to us by the statistics; I believe that as always, there will be a turning point in this love affair; I think it's possible the "less than wonderful" resolution to this debt ceiling story may take a little gloss off of the bonds.

Paper CRUSHer's picture

Btw,it was me ol' grandpa juiced to tell chilling tales 'bout the future of the economoney. Working as a part-time clairvoyant possessing telepathetic powers ol paps wrote a poetic log of his visions and warned of this decades ago.

Although 99% of his predictions failed to come trus including the 'Dow To 36000' long before it was ever made public,this however stands out......

DATED AUG 15th 1971........Coincidence?




















gaoptimize's picture

Exactly what economic factors do the CBO think are going to change to make next year's deficit less than this year's?  I wish that every time someone posts these CBO decifit projections they were accompanied by the projections from 1, 2, 5, and 10 years prior compared to actuals.

CrashisOptimistic's picture

All CBO baseline projections presume 3+% GDP growth.  That translates into tax revenue and that cuts the deficit.

There are also Iraq wind-down costs in the baseline that reduce spending.

The one thing that the CBO projections never do is raise interest rates in response to their presumed GDP pop.  If they did that even 1%, the 15 trillion debt generates another 150 Billion in spending.



TSA Thug's picture

Listen. The fact is that this discussion is nonsense.

Corporations are sitting on huge bundles of cash and soon they will plow into US Debt like crazy. The writing is on the wall. Ignore it at your peril.

Like Glenn Beck said today: "There will be change in this country like most do not expect". And I'm sure he was talking about the bond market. Glenn is a real patriot who everyone should be listening to if for nothing more than to expand your intellect.


--You WILL Obey!

SheepDog-One's picture

Glenn Beck Mormon Zionist shill I've got no use for that crybaby fraud.

Long-John-Silver's picture

For a "crybaby fraud" his predictions have been running at least 90% correct.

I know I am way ahead with my Gold and Silver investment.

He also predicted this debt blowup years ago when he was on CNN.

TSA Thug's picture

"Glenn Beck Mormon Zionist shill I've got no use for that crybaby fraud."

This sort of slander from you WILL END NOW! You're jealous is showing so pipe-down.


--You WILL Obey!

IQ 145's picture

I almost decided to Google Glenn Beck just to find out who he is; but then I thought, nah. I've got along this far without dipping into the popular culture; I don't want to get any on me. He's one of those AM radio wing-nuts, isn't he?

Central Bankster's picture

No they won't, because shareholders will force them to either distribute the cash or invest it wisely ( not in something with a negative real return).

TSA Thug's picture

You may be thinking of shareholders from days past.

The new shareholder mentality is rooted in preservation. Circle the wagons and prevent erosion of the very foundation that you and your fortune have been built upon.

A Renaissance if you will.


--You WILL Obey!

Hearst's picture

If the Republican tactic is to purposefully not reach an agreement with the Democrats  so that a default happens and a 'derivative event' takes down the bankster's grip on the US since 1913, then Boehner and the Republican's hard stance of not giving in to the white house makes sense.

wang's picture
wang (not verified) Hearst Jul 28, 2011 10:48 AM

The strategy of the statists (D&R) is to rid themselves of the tea party either by getting them to cave and/or framing them as the cause of the pseudo default. My guess is the TP will cave but if not then we'll have drama Monday and Tuesday and a resolution by Friday of next week. The media and the "leadership" of both parties will lay the blame at the foot of the TP (now being labeled as right wing extremists by the MSM) who are a threat to the Dem and Rep establishment.

JR's picture

The crisis is going to vindicate the Tea Party whether they cave or not, IMO,  because they have been the ones creating this much needed friction.  Even if the entrenched Ds&Rs roll over them now, or even if the TP agrees to go along, it seems to me that they are the harbinger and result of Americans beginning to stand against this bailout government.  And that’s only going to continue, IMO.

IOW, this is a movement that can’t be stopped; a Tea Party defeat today is just a lost battle in a war where the bankers are making a last stand. And the TBTFs are going to be defeated because the rising current is going to continue against them.

The war has been long in coming.  Now the war is here.

You are right about Republicans demonizing the conservatives: Banker buddy John McCain already has stepped out to criticize the TP and Congressman Paul Ryan (R) was on radio yesterday bad mouthing the Tea Party while making a call for lifting the debt ceiling.  He dismissed any idea of a 1% across the board cut in all government departments in case of a government refusal to implement any future cuts.  Why?  It would cut military spending!

Said Ryan: We need to raise the debt ceiling, avoid the contention, and deal with the debt problem in 2013 when the Republicans take over the presidency and both houses of Congress.

Where have I heard this before?

BTW, wang, I always note and value your analyses.

Hero Protagonist's picture

I wish, however, the fact that Boehner and the Republican party was an accomplice to bailing out the banks with our money and then letting that same industry pay bonuses would indicate that this is NOT their tactic.

Dr. Engali's picture

I think both side know we are fucked. It's just a matter of who gets the blame. There is nobody left to buy our debt,other than uncle Ben and his magic printing presses.

Hearst's picture

That's my point.  The Republicans and Democrats know the end of the fiat Dollar is nigh.  The Republicans will sieze power by allowing the default to happen, kill off the criminal banking powers that have strangled the country for so long, and come off as the hero's in the end.  And that end will be a wiping clear of ALL debt held by the US government and privately.  Unfortunately this will mean that all paper and electronic money denominated in in US Dollars is also worthless.


Enter new constitutional monetary standard in the US.  Got Gold and Silver? 

Z Beeblebrox's picture

It's a nice scenario to think about, but I doubt the coming collapse will be used to benefit the people. More likely we move to the Bancor, and the IMF/BIS or a new international central bank is given complete rule over the planet, based on the same fiat model, now globalized.

A monopoly over the monetary system is one of the most horrific evils imaginable. That's why it will happen. World socialist dictatorship, here we come.

Downtoolong's picture

I'm more inclined to believe that the Republican tactic is to create havoc and panic in the market to stimulate lots of transactions and trading. That helps Wall Street right now more than anything by adding commissions, fees, and trading margins to their bottom line.

This isn't about our long-term future; it's about the next 90 days. And the Tea Party thinks it's all for them, ha!

slaughterer's picture

If the US defaults, I am very sure that a good portion of the bankers will do quite well with their credit derivative positions on US sovereign debt.  Many of them levered up their bets on a US default this month.  If the Boehner plan leads to a default, Boehner will be a hero of Wall Street and probably ensure millions of dollars of campaign contributions for he Republican Party from Wall Street for next year.   What remains to be seen is how the Fed and giant funds like PIMCO levered up their credit derivative positions against US debt.    I am sure they will do very well in any default situation.   

Chief KnocAHoma's picture

These positions will get slaughtered in a true default.

Here have all the FRNs you want, since the USA will now being working with a new commodity backed currency, and all you banking bitches can whine all you want and threaten to take down the economy, but that trick ain't gonna work again, so blast off.

I am The Chief

Chief KnocAHoma's picture

Ding ding ding...

We have a winner!

Stay strong

I am The Chief

Dr. Engali's picture

The average lifespan of all fiat is 40 years.