The US Treasury Department has released a statement indicating that it has around $231 billion in liquidity left to avoid a potential debt meltdown of approximately $32 trillion.
Of this amount, around $143 billion is in cash and cash equivalents, and $88 billion is from “extraordinary measures,” which involve accounting and investment strategies.
This balance has decreased from the initial amount of about $333 billion authorized earlier in the year.
The deadline for resolving the potential default approaches quickly, with Morgan Stanley estimating that the government will run out of liquidity in August. However, Treasury Secretary Janet Yellen has expressed concerns that this could happen as early as June.
Despite this situation, both equity and fixed-income markets seem to be ignoring the debt ceiling issue. The S&P 500 is up about 8% since the beginning of the year, while a basket of long-dated treasuries (+20 years) is up 3%.
In the past, when the government has faced a debt ceiling, political parties have used the situation to push for policy changes.
Over the past five decades, the debt ceiling has been raised 74 times, including 18 times during Ronald Reagan’s presidency, eight times under Bill Clinton’s tenure, seven times during George W. Bush’s administration, and five times while Barack Obama was in office.
Currently, Republicans are seeking to cut government spending as a condition for raising the debt limit, citing the need for more austerity given rising interest rates.
Meanwhile, Democrats are calling for an increase in the debt ceiling without additional conditions, arguing that pressing issues such as climate change, inflation, and the war in Ukraine require sufficient fiscal expenditure to support the economy.
similar situation in 2011 when the Obama administration had to negotiate with a Republican House, and a discussion around a substantial fiscal expansion took place.
This led to concerns about an impending recession, and the result was a standoff that caused Standard & Poor’s to downgrade the U.S. sovereign debt rating from “AAA” to “AA+.”
U.S. Treasury’s Precarious Situation
During that episode, the S&P 500 rapidly declined by 17% in just 22 trading days. Although the debt limit was eventually raised on August 2nd, the equity markets did not reach their lowest point until six days later and fully recovered only about 6 months later.
Meanwhile, treasuries rallied, and the yield on the 10-year treasury dropped from close to 3.5% to less than 2% from February 2011 to February 2012.
Failing to raise the debt ceiling would be catastrophic, as it would result in the United States defaulting on its financial obligations, damaging its credibility, and causing significant disruptions in financial markets.
The result could be higher expenses for borrowing, a decline in trust from investors, and the possibility of significant economic disorder with widespread impacts at both the national and international levels.
As the debt ceiling situation unfolds, the best-case scenario for the economy and markets would be a deal reached before the X-date without implementing austerity measures.
On the other hand, the worst-case scenario would be a deal reached after the X-date, accompanied by significant austerity measures, posing a high risk to the economy and markets.
A potential downgrade of US debt could occur due to the current political instability and inability to effectively manage finances.
Warren Buffett, whose company Berkshire Hathaway now holds more liquid spending power than the US government, has warned about the danger of not raising the debt limit.
Similarly, the debt ceilings are a mistake, and the United States debt capacity is different now than it was in 1911. Investment diversification is crucial given the various economic risks, including high inflation, regional bank crises, and the Ukraine-Russia conflict.
In such situations, it is advised to have diversification across asset classes, thematics, and geographies and recommends investing in high-quality international equities, long-dated fixed-income securities, cash or short-dated fixed-income securities, and non-cyclical commodities such as gold and palladium.
