David R. Kotok, July 23, 2024

(The following was first published on Cumberland Advisors’ website and via LISTSERV. For details, visit https://www.cumber.com/.)

The US debt aggregate is about to cross $35 trillion; the vocal anti-debt Republicans have become silent; the Republican platform and the Republican National Convention essentially ignored government debt. Does anyone remember the Speaker McCarthy-President Biden debt standoff and the debt ceiling fight? IMO, McCarthy did the right thing to resolve the issue.  Note that the “Crazy 8” House Members who organized the ouster of Speaker McCarthy are now fewer in number.
 
Here’s a column from Yahoo Finance on the state of this issue today as the Trump-Vance campaign advances in this election year: https://finance.yahoo.com/news/the-us-debt-is-about-to-hit-35-trillion-its-barely-come-up-at-the-gop-convention-134447204.html.
 
Meanwhile, the pledge by Speaker Johnson to not use the debt ceiling has been honored to date. And credit default swap pricing on US Treasury creditworthiness has improved. Markets are adjusting the pricing of CDS, which seems to suggest a Republican sweep. I will have a detailed writing on this CDS change in the future. A Republican sweep suggests that there will be no federal default threat impacting US Treasury debt markets next year. Markets expect that there will be agreement on budget matters because the Trump White House may have majorities in both the Senate and the House. That means the Republicans could pass a budget (using the CR) with simple majorities in both congressional chambers. 
 
This outlook can change abruptly now that the Democrats have to decide a new presidential ticket and the debate in the country’s political attention span morphs from Biden’s age dysfunction and Trump’s age and assassination attempt. We expect the national voting outlook to change at once.  We hope for a true policy debate over tariffs or climate or taxes or global war risk or public health or immigration or Social Security trust Fund deficiency or women’s rights, or if there should be term limits or an ethics code applied to the US Supreme Court.  There’s plenty to discuss instead of focusing on Biden’s or Trump’s ability to read from a telepromter.
 
The issue of deficits is still alive. Here’s an analysis from the Committee for a Responsible Budget (CFRB): “Who’s to blame for the national debt? How about everybody?” https://finance.yahoo.com/news/whos-to-blame-for-the-national-debt-how-about-everybody-132241598.html
 
And here’s the link to our former writing on the budget when Doug Kass joined the conversation: “Doug Kass & Me on Debt & Deficits,” https://www.cumber.com/market-commentary/doug-kass-me-debt-deficits-0
 
Now let’s offer some views of readers.
 
Jeffrey contributed:
 
Dysfunctional US elected leadership = greater ultimate risks of reckless finances = greater risk of potential default = higher market demanded interest rate to compensate for those continued/increased risks of default = high insurance against default/CDS spreads. It all makes sense to me. We can still turn the battleship, but we need to start sooner rather than later. Slightly higher US government borrowing rates today (other than what we would face if we had more fiscal discipline) is the “gradually” part of the quote below. We will have to see when we get acceleration in those rates before we get to “suddenly”. I must admit I have on occasion misquoted Hemingway on this instead saying, “slowly, then all at once”. The meaning is the same and I slightly prefer my misquote alternative of “then, all at once” to his “suddenly”. But, he is the more noted author. JR

Steve B. sent me a note from Thunder Bay, Canada, as he wanted to set the record straight:
 
Until today your emails have contained in my experience only accurate content. Then this:
 
On 2024-05-05 8:04 a.m., David Kotok & Cumberland Advisors wrote:
“The second monetary attempt was after the adoption of the US Constitution. The war of 1812 was financed. Fortunately, America won.” 
 
Actually, that may be the happy interpretation in textbooks used in U.S. schools, but it is not really true. The U.S. invaded Canada several times to wage a land war to exert leverage on Britain that otherwise had overwhelming naval superiority of about 500 ships compared to America’s 16 warships. Land invasions and short occupations into Canada were unsuccessful in that the Americans always had to withdraw. Of course our textbooks had Canada winning, but in reality it was rather a draw. Best regards from Thunder Bay, Ontario, just north of a border that continues to exist.
 
A different David sent this thoughtful note:
 
I think you know my position on deficits and the hair on fire financial guys who argue for some kind of draconian change in the imbalances that have always existed in any economy in part by the factor of time between action and reaction. The cost of trying to get the economy into balance would be to send it careening with no real purpose into an even greater calamity, think Herbert Hoover and the Fed’s solution to the market collapse of 1928-29. If we were able to start with perfect balance, say during Clinton’s brief moment of glory, and religiously add revenues as we add services so that the benefits of replacing income lost by the rich with spending of the poor, rather than cutting taxes for the rich and cutting outlays for the poor, and even if you were to believe that the wealthy would then put that money into the bank, the banks would then lend it at low rates to worthy capitalists, and all will be better as wages increase, the time displacement between the tax cut and spending cuts and the effects of the money being placed in better uses than feeding the hungry or clothing the impoverished, but in worthy investments by already overly benefited rich people, then maybe some kind of balanced fiscal and monetary policy might be the policies of an economically gifted Congress, but it is not. 
 
There is a good solution to the problem and you won’t like it, none of those deficit hawks will like it, not the David Walker fan club, but it is there. Simple bill – 10% surtax on all income taxes or if we want a 5,10,15 surtax depending upon the income strata – this includes Social Security, Federal income taxes, and Corporate taxes, no cap on Social Security income taxed. The money is used to retire the T bills outstanding, earmarked for just that purpose, I’d leave it to people like you to figure out which ones are redeemed first. I would also let the Trump tax cuts expire. Figure out how much money that would raise and this is the answer to the problem, not a hard bill to write, but impossible to pass. All the Deficit hawks want to do is be cruel and they will shut up if it has to come out of their pockets.
 
I’m getting further along on my economist lament, and I keep thinking of what is right and what is wrong with today’s system. I see that others are in the same boat. Stiglitz just published his version of this today and Angus Deaton, another Nobel Prize winner, has published another rebuttal of modern day economic orthodoxy. The difference is that they will be read, I won’t, but who cares.
 
Frank turned up a gem:
 
Here’s a pretty good add-on: a discussion of the economic landscape between Rosenberg & Gundlach.
 
Unfortunately, even for those of us in our mere 60’s, the problem you and Doug Kass are describing, echoed by Rosenberg & Gundlach, is being ignored by the politicians of today. Worse, we’re looking for leadership from two wealthy guys who are likely both in the last decade of their lives. More debt to either of them just won’t matter. We need to start making hard choices before, as Gundlach implies, we no longer have lenders throughout the world who will be willing to allow the USA to borrow what it will need. Certainly, the current geopolitics, where monetary and financial restrictions are weaponized, suggests that our near-peer competitors would love to see the USA default on our debt.
 
“Jeffrey Gundlach in Conversation with David Rosenberg | The Bond King Returns,” https://www.youtube.com/watch?v=oCZ8Zxqc5fI
 
Tip Thornton weighed in with this: 
 
David, may we reduce this to a few basics? Most Americans and mainstream economists believe the federal government (including the Federal Reserve System as is agent) is like everyone else and has to get dollars before it can spend them. They believe that when it runs budget deficits and pays more dollars into the economy than it takes out with taxes: 1) It must borrow dollars from the economy by selling securities to make the payments; and 2) Its payments add dollars to the economy that may lead to inflation. 
 
The two beliefs conflict. 
 
Either: 1) It borrows dollars from the economy and pays them back without adding more, so the deficits cannot lead to inflation; or 2) It may cause inflation because it issues and adds more dollars when it makes payments (which the belief says it cannot do) and therefore it does not have to sell securities. The deficits may lead to inflation so beliefs 1 and 2 cannot be right. This proves that explanation #2 must be incorrect. A modern view explains that the federal government is not like all others, it is unique. It is the only entity authorized by the Constitution to issue dollars. All others are dollar users and must get them before they can spend them. The economy needs a continuing influx of new dollars in order to grow. The government issues new dollars and pays them into the economy when it runs budget deficits. This is a normal government operation and nothing to fear. What is called the federal debt is just the running total of new dollars the government has created by running deficits since 1789. A government deficit is also a private sector surplus (ignoring the foreign sector). The government debt is in securities that are private sector assets. If the debt is a problem, so are the assets. A balanced budget requirement would prevent the. issuance of any more new dollars when the economy needs them, as it often does. 
 
The new dollars the government issues can be called “durable” dollars because they remain in the economy until the government takes them out by running surpluses. (They are distinct from “transient” dollars created by banks and other lenders that disappear when the loans are repaid. The number of transient dollars expands and contracts like an accordion while the number of durable dollars normally just grows.) The government has run large surpluses five times in the past two hundred years that reduced the debt by and the number of durable dollars by more than 25%. Each time led to a major depression and government had to run large deficits to replace the durable dollars and help the economy recover. The Great Depression of 1929 was the last of the five, and the economy needed the deficit spending of the New Deal and World War II to recover. In the history of the country, budget deficits have caused no other major harm than inflation, while surpluses took dollars out of the economy and caused great harm. 
 
Alexander Hamilton wrote, in a letter to Congress, that federal securities are much like money and can be sold or used as money for many purposes. That is why the government does not take dollars out of the economy when it sells securities as it does when it collects taxes. Taxpayers give up net worth or purchasing power. Securities buyer just exchange dollars in their checking accounts for Treasury securities of equal value. Treasury bills are even called cash equivalents. The sales are like changing two nickels for a dime. The buyers give up no value and the government gets none in return. That is why, when the government runs deficits, its security sales do not affect the amount of dollars in the economy and the payments add new dollars that may lead to inflation. 
 
Inflation can be a serious problem, but that is an entirely different issue from whether the government creates new dollars in the first place. Climate change is already having inflationary and deflationary effects that differ among industries and regions that cannot be managed with monetary and most fiscal controls. And the effects will grow. But at the most basic level, Government deficits equal private sector surplus (ignoring the foreign sector). The Government’s debt is in the form of securities that are private sector assets. Requiring a balanced federal budget will result no more dollars when the economy needs them. Securities should be sold when the financial system needs them, not so the government can get dollars which it creates. The present system is like having a baker borrow a slice of bread. 
 
I suggest that anyone who disagrees with this analysis answer the following question: How can the federal government add dollars to the economy that may lead to inflation if it borrows them from the economy by selling Treasury securities and just pays them back without issuing and adding more to the process? (This ignores interest costs that may rise.)