In the next week the U.S. government will likely hit the debt limit ceiling of $14.3 trillion, an occurrence that would be a large concern if it were not already presumed Congress will vote to raise it, with most expectations for a $2 trillion increase.
However, two key items are brewing here that can bring large scale issues to fruition in the next year or two. The first being, once we have eaten up the allotted increase in the debt ceiling, which will most likely be right after the Presidential elections (how convenient), the U.S. government will for the first time in history have debt that is larger than Gross Domestic Product (GDP).
The second item is the continued partisan environment between Republicans and Democrats over U.S. government spending and how to cut into what has become a runaway freight train of debt. With tensions running high between parties the chance of Congress not passing another increase to the nation’s debt ceiling sometime in 2012 because very real.
The implications from both these items are not pretty. If the U.S. were to hit the debt ceiling and ultimately default by not making an interest or principal payment on its debt, money-market funds and pension funds with large Treasury bond holdings (as most have) would suffer tremendously as interest income would not be received.
Money-market funds would likely see a run on withdrawals (just like when troubles brewed in 2008) and the funds would not have the cash on hand to meet those requests. First, because they would not be able to sell the Treasury bonds fast enough, and second, those bonds would sell for less as rates will be on the rise.
This is because U.S. investors will demand a much higher rate of return to hold Treasury bonds. This drives down the prices of existing bonds, therefore pushing the yields up to market value of newly issued securities.
Our government can certainly take actions to avoid something like this even without raising the debt ceiling again next year (drastic spending cuts that are many multiples of what we’ve seen thus far), but who in Washington will really step up and go after that?
The real underlying issue is politicians are making these decisions; these are individuals whose first and foremost motive is re-election. So I ask, who is going to take a stand and risk their political future? I don’t see many jumping on that train until absolutely necessary, which will likely be when the tipping point is reached on the above issues.
By the way, currently for every dollar the U.S. government spends, 42 cents of it is borrowed.
Another Look At Rising Prices
Touching back on our last letter, the pricing pressure we are seeing has gained further momentum as evidenced by consumer staple giant Kimberly-Clark, who announced last week it will be raising prices on products. The announcement comes just a few weeks after last month’s news that prices for Scott tissue, Cottonelle and Huggies Diapers were being bumped upward of 7 percent. The company said costs are likely to be twice as high as they expected, hence we get a second set of price increases just a month later.
This is a trend I have previously pointed out, one of which may not see the relief over the coming summer that I had previously hoped for as the Federal Reserve made it rather clear in its speech last week that monetary policy would remain extremely accommodative even after the conclusion of QE2. (To better grasp the impact of Quantitative Easing (QE) on pricing pressure, please refer to the past two letters)
Without any surprise, Gold, Silver, Oil, etc. rallied late last week. Gold & silver are both pressing all-time highs. So long as the Fed doesn’t change its tune, I will remain bullish on gold.
Your hoping for a huge buyable pullback in gold analyst,
Mitch Jaworski