Tuesday was the deadline for US individuals to submit 2022 tax returns, and an initial read on the data indicates a steep drop in receipts. According to Goldman Sachs economists, tax receipts are down 39% from the same time last year, perhaps hastening the need to increase the debt ceiling. While the base case is still July for a need to raise the debt ceiling, June is now on the table given how receipts are running. Either way, the $31.4T cap will need to be lifted at some point soon, an event that has resulted in much hand wringing, political jockeying, and ultimately concerns about the financial health of the United States. Even though the debt ceiling has been raised numerous times in the past without much drama, the political divide and change in the composure of the legislature might be reasons for a less-than-orderly event this time. With that, we find it instructive to look at the events surrounding the 2011 debt ceiling crisis, which resulted in a downgrade of the debt rating of the US by S&P, a spike in market volatility, and a drop in the stock market.
The debt ceiling, the maximum amount of debt Congress has authorized the US Treasury to issue, dates to 1917 when the Second Liberty Bond Act was passed. The law allowed Treasury to issue debt without explicit congressional approval if it fell under a certain amount, i.e., the debt ceiling. Prior to 1917, Congress would authorize the Treasury to issue specific debt instruments usually for explicit purposes. The change allowed the Treasury more flexibility in funding the US government’s obligations, but it came with the need to approve higher debt limits periodically. While the change in the debt ceiling has been raised numerous times without much drama, certain instances, such as 2011, have been fraught with much acrimony. In addition, over the past years the debt ceiling, charted below, has increasingly been suspended (5 times since 2013) or operated without an explicit limit (3 times since 2017) due to the use of extraordinary measures by the Treasury – suspending the investments and funding of certain government programs.
Our math indicates that since 1940, the US debt ceiling has grown at an 8.1% annual rate. The exponential growth in the debt ceiling and US debt comes as the US economy grows but at a slower pace than debt growth. As a result, the ratio of the obligations of the US government to its economic output, the debt to GDP ratio, has shown significant secular growth as well as growth in response to specific economic crises, such as the Global Financial Crisis and Covid-19.
Looking back on the events surrounding the 2011 debt-ceiling crisis, there are important observations. The first is the relative market calm ahead of raising the debt ceiling. Market volatility as measured by the CBOE Volatility (VIX) Index was subdued, trading in a range of the mid-teens to lower 20s range, with one spike up to nearly 30, and the S&P 500 had been bouncing in a 100-point range, from 1250 to 1350. This is despite several warning signs from credit rating agencies, who had put US debt on negative revision watch.
Another observation is that the debt ceiling was already reached well ahead of the resolution being signed into law. The debt ceiling had been reached on May 16th but then-Treasury Secretary Tim Geithner could meet financial obligations until August 2nd using “extraordinary measures”, essentially forgoing other obligations to keep the government in operation. Current Treasury Secretary Janet Yellen has already outlined these measures, should they be required. Ultimately, these measures could postpone the need to raise the debt ceiling, but not eliminate it.
The final observation is that the market volatility, rise in the VIX, and drop in stocks, did not come until after the debt ceiling was signed into law. After the debt ceiling was raised, the S&P 500 cratered 12% to 1,100 and the VIX spiked to nearly 50. Our read is that this had more to do with the US debt downgrade by S&P than anything else at the time. The downgrade cited the “weakening of American policymaking and political institutions” and that “America’s governance had become less stable, effective, and predictable,” words that might ring true for many today.
Bitcoin was still in its infancy at the time, so we hesitate to read too much into its price reaction in response to the events of 2011, but today is a different story. It might be that bitcoin, as a non-sovereign issued store of value, is seen as a valid investment option for those seeking to insulate themselves from the machinations of politicians and monetary policy setters. There is something settling about the certainty of the economic promise that bitcoin gives, one not given by fiat currencies and public spending.
An important measure of the current state of the banking crisis that emerged in the first quarter, bank borrowings from the Federal Reserve, have receded from the highs over recent weeks, indicating that the most pressing stresses might be behind us, for now. Borrowings from the Fed’s discount window as well as draw on the newly created Bank Term Funding Program (BTFP) have trended off their March highs, although ticked up again this past week. Given this recent uptick, plus what we know about the protracted nature of past banking crises, has us hesitant to signal all is clear. The root causes of the crisis, losses sustained on the asset side of bank balance sheets due to rising interest rates combined with skittish deposit bases, have yet to be fully resolved. Pulling back from the worst of the crisis has likely affected bitcoin, which was a beneficiary when solvency fears rippled through the banking system. While banking crises are rare occurrences in the US, unfortunately, it often takes these episodes to remind us how fragile the banking system can be, and the reason that Bitcoin was created. It is not a coincidence that Satoshi chose “Chancellor on the brink of second bailout for banks” as the message encoded in Bitcoin’s genesis block.
Bitcoin fell 7.5% on the week, failing to hold the $30K level and ending the week just below $28,100. Traders seemed to take the opportunity to lock in gains after a precipitous price rise this year, which still has year-to-date returns of just below 70%. Regulation continues to be topical with investors as the SEC filed a complaint against the Bittrex exchange, and there were hearings on stablecoins and oversight of the SEC, including its involvement with digital assets. Equities also fell on the week, with the S&P 500 down 0.4% and the Nasdaq Composite down 0.9%. Commodities fell as well, with gold down 1.7% and oil down 5.9%. Bonds were no haven this week either, with investment grade corporate bonds down 0.7%, high yield bonds down 0.9%, and long-term US Treasuries down 1.0%.
Apr 28 - CME monthly expiry
May 3 - FOMC rate decision
May 10 - CPI release
May 18 - Bitcoin 2023 Conference in Miami
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