On Saturday, President Biden announced a critical debt ceiling agreement with House Speaker Kevin McCarthy (R-Calif), stating that it essentially averts "the worst possible crisis: a default for the first time in our nation's history". This principal agreement appears to be a breakthrough in the tense fiscal negotiations. Yesterday, McCarthy revealed the text of the bill - the Fiscal Responsibility Act 2023 - to the public. He proclaimed the bill "does what is responsible for our kids, what is possible in divided government, & what is required by our principles."
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In order to usher the proposed legislation through an increasingly divisive and finely balanced Congress, McCarthy, along with influential Democratic figureheads, will need to craft a bipartisan alliance. This coalition would consist of House and Senate members from both political aisles, prepared to lend their support.
The ultraconservative House Freedom Caucus, however, has already initiated a fierce campaign against the plan. They contend that the plan falls short in implementing substantial reductions in spending. Furthermore, they have issued a stern warning about their intent to obstruct its passage.
The Deal That Made
Answering to GOP preferences, the newly formed agreement augments work conditions linked to federal food stamps and family welfare benefits. Republicans had been advocating forcefully for comprehensive modifications to these and the Medicaid health insurance scheme. Despite their efforts, the deal excludes additional work prerequisites for Medicaid. The specifics remain somewhat nebulous, but the pact does raise the age criteria for work requirements to obtain food stamps from 50 to 54. Consequently, beneficiaries like a 52-year-old woman, presently receiving food stamps without having to meet a 20-hour work week, might be mandated to do so under the new arrangement.
Concurrently, the deal paves the way for homeless individuals and veterans to more easily acquire food stamps. However, projections from the administration suggest the debt ceiling agreement will, on balance, result in fewer people on food stamps being subjected to work requirements, according to a White House official. These alterations are slated to phase out in 2030. As part of the changes to the Temporary Assistance for Needy Families programme, states will be required to ensure a larger proportion of their welfare recipients are employed, although the increase is not as substantial as what Republicans had envisaged.
The X-Date
Treasury Secretary Janet Yellen, in a recent communique to Congressional members on Friday, confirmed that the Treasury is set to meet its scheduled disbursements. This includes an array of payments exceeding $130 billion, earmarked for June 1 and 2. These payments are intended to cater to veterans, Medicare providers, and Social Security beneficiaries.
Yellen has forecasted that the week commencing June 5 could see the government confronted with a liquidity crisis, an inability to cover all of its impending bills. It appears that June 5 has been delineated as the critical 'hard deadline', the X-date, following the earlier warning of a more flexible 'soft deadline' on June 1 and 2.
The so-called "triumvirate" of rating agencies - Moody's Investors Service, S&P and Fitch Ratings - wield considerable influence over the credit evaluations of corporations, regional governments, and even whole countries. All three firms have intimated potential downgrades to the US's credit standing if the legislature does not promptly action a bill to increase the debt limit. As a case in point, Fitch, earlier last week, dispensed a harsh admonition, positioning the superior-rated US credit under a negative ratings watch.
Possible Contingency Measures
In our preceding commentary, we examined the potential 'emergency' strategies President Biden could resort to, should he fail to negotiate a consensus with the GOP-dominated Congress. These options include:
Employing budget reconciliation: A procedural manoeuvre, this tool allows Democrats to push through specific legislation via a straightforward majority vote in the Senate, thus circumventing a filibuster. Biden may wield this instrument to raise the debt ceiling sans Republican support, as suggested by certain Senate Democrats. Nevertheless, this alternative could encounter stumbling blocks such as the requisite unanimity among all 50 Senate Democrats and adherence to reconciliation regulations.
Enacting the 14th Amendment: This constitutional clause upholds the inviolability of the public debt of the United States. According to a subset of legal academics and legislators, Biden could exploit this provision to unilaterally raise or abolish the debt ceiling, or to instruct the Treasury to persist in debt servicing, regardless of the ceiling. However, this approach invites controversy and carries inherent risk, given its potential to incite a constitutional crisis and spur legal disputes from Republican quarters.
Coining a platinum coin: This inventive proposition hinges on the exploitation of a legal grey area that permits the Treasury to mint platinum coins of any denomination and deposit them with the Federal Reserve. Hypothetically, Biden could mint a $1 trillion coin (or more) to service some debt without necessitating a hike in the borrowing limit. However, this untested tactic invites scepticism, as it could undermine the perceived integrity of the US currency and monetary framework.
Previously, whispers circulated suggesting President Biden might contemplate invoking the 14th Amendment as a tactical move in the debt ceiling dispute. However, Deputy Treasury Secretary Wally Adeyemo dismissed such speculation last Friday, saying, "I believe the President and the Secretary are clear that this won't be a solution to our present predicaments. So, in short, that's a 'no'", as he responded on a CNN interview on Friday morning. He confirmed that the President's singular priority was to engage in negotiations with the GOP-led Congress to reach a mutually acceptable agreement.
Yet, just yesterday, President Biden veered slightly from this stance. While he dismissed the notion of completely abolishing the debt limit, he did indicate his willingness to explore the potential utility of the 14th Amendment in future debt ceiling altercations. This came after he and Speaker Kevin McCarthy (R-Calif.) successfully struck a deal to sidestep a potential default.
The Last Measure
In light of our analysis of the contingency plans at Biden's disposal, it seems apparent that the President isn't likely to consider budget reconciliation as a solution, given the entrenched polarisation in American politics. Concurrently, doubts persist over whether McCarthy can secure unwavering support from all GOP members, particularly the influential Freedom Caucus. Historical voting patterns in the House of Representatives reveal instances where the Freedom Caucus has leveraged its power to negotiate key congressional committee appointments.
Biden's first preference appears to be a negotiated settlement with Congress, aimed at tempering the hyper-partisan climate. However, his remarks from yesterday suggest an open-mindedness to invoking the 14th Amendment. This remains a viable option, particularly if legislative consensus continues to elude Congress.
However, a range of appointments, including the elevation of Federal Reserve Vice Chair Lael Brainard to lead his National Economic Council, signal broader possibilities. Brainard, a Ph.D. economist, has been thrust into a pivotal role for policy coordination, liaising with business leaders, and navigating negotiations with Congress. This implies that a third option - minting a platinum coin as a temporary solution - remains on the table as a potential contingency plan. As we previously analysed, the requisite infrastructure, such as Project Hamilton, is already established.
Moreover, the incorporation of seasoned Federal Reserve veterans like Brainard and Yellen into the economic team appears to be reinforcing the nexus between the White House and the Fed. As the final arbiters of monetary policy, this strengthening relationship suggests that we cannot dismiss the potential for unconventional solutions, such as minting a platinum coin.
Investing can mirror the capricious nature of the sea: tranquil at one moment, tempestuous the next. On the distant horizon, the spectre of an impending debt ceiling crisis casts a foreboding shadow. Navigating this complex financial seascape calls for a reliable beacon and a sturdy vessel helmed by a seasoned crew. In the realm of investing, Modern Portfolio Theory (MPT) is our guiding lighthouse.
Our MPT
MPT delineates the trajectory towards a balance of risk and return, steering investors towards efficient asset allocation. It casts the light of diversification, scattering investments across a spectrum of asset classes, sectors, and locales. This stratagem seeks to mellow the churning waters of market volatility, allowing the investor's vessel to stay its course.
Nevertheless, the looming debt ceiling crisis stirs the deep, underscoring the potential tempests that can abruptly disrupt our investment voyage. While MPT's beacon promotes diversification and cushions potential risks, it does not innately safeguard us from financial maelstroms. To withstand these, our vessel needs the reinforcement of rigorous risk management techniques and hedging strategies.
Active risk management techniques, such as stop-loss orders or tactical asset allocation, form the robust hull of our ship, affording an extra layer of protection. These maneuvers equip us to tweak our portfolio in response to mutable market conditions.
Hedging strategies serve as anchors, steadying the ship amidst market turmoil. Derivatives like options or futures can offer stability, shielding against potential downturns sparked by events such as the debt ceiling crisis.
Like a seasoned sailor relying on a trusty compass, alternative investments guide us towards opportunities untouched by conventional assets. They encompass entities like hedge funds, real estate, or commodities, adding further diversification to our portfolio and potentially curbing downside risk.
Yet, with the shadow of the debt ceiling crisis looming, active steering of our investment ship becomes essential. MPT recognizes that transient events can reshape the financial landscape, influencing expected returns, volatilities, and correlations. Regular portfolio reviews and rebalancing function like a sailor's periodic recalibration of the ship's route, ensuring alignment with long-term financial objectives, regardless of proximate upheaval.
In sum, Modern Portfolio Theory provides the guiding beacon, leading us towards optimal risk-adjusted returns over the long haul. However, the forthcoming debt ceiling crisis serves as a stark reminder that MPT's guiding light must be buttressed by a sturdy vessel of risk management techniques, an anchor of hedging strategies, a compass of alternative investments, and the disciplined navigation of regular portfolio fine-tuning. When these components coalesce, we can navigate the capricious waters of investing, weathering not only the debt ceiling crisis but any storm on the investment horizon.