David L. Blain, CFA, CEO of BlueSky Wealth Advisors, and author of “Invest In Your Life, Not Just Your Portfolio,” shares insights on the U.S. debt ceiling standoff and what it means for you.
Transcription of David’s video:
(00:00): Hi, everybody. Thank you for joining me today for this very important topic. We’re going to be talking about the debt ceiling standoff that’s currently occurring, and there’s a lot of emotions running on both sides of, of the aisle, Democrats and Republicans. Fighting again about the debt ceiling. I’m going to give you some facts today. We’re going to try to stay away from the political angle of this. I think there’s plenty of blame to go around, which we’ll get into a little bit. But for those of you that know me, you know, I, I don’t watch tv. I don’t watch Fox News. I don’t watch CNN. I don’t read the the majority of the traditional, you know, New York Times, Washington Post. That the political angle in all those media sources has really become detrimental to our national discourse. And so what I focus on are facts: actual hard facts, numbers, data, things like that.
(01:04): And that’s what I’m going to bring you today. I may mix in a little bit of opinion, but it’s informed opinion based on, on those facts and, and history. And that’s the way I approach markets. You’ve also probably heard, you know what, I went to school years ago. We studied different subjects. One subject was political science. Another subject was economics. And those two were separate disciplines. Today and in the world we live in today, I call it “polynomics” — sort of the conflation of those two terms, politics and economics. And unfortunately, you can’t separate the two today. The federal government, government spending state influence in our lives has ballooned to an effect. The use can’t ignore. I mean, they are so well embedded into our economics and, and the way that we live our lives, that unfortunately, you can’t separate the two.
(02:01): So we’ll have to bleed a little bit into the political side of this, but hopefully we’ll just stick to, to facts. And you can, you can draw your own conclusions. I’ll provide some of my own, but it’s certainly an issue, the debt standoff that we’ve seen before. And that’s kind of sad.
We Keep Running Into This Problem
We keep running into this problem numerous times in our history. We keep running into this problem. Most recently, the big one was 2011, for those of you that may remember, I certainly do. That was the another similar situation when we had a divided Congress meaning divided Congress, a Democratic president and we were brought to the brink of default back then Standard & Poor’s, which is a bond rating agency. They look at the debt of companies and countries, and they assign them ratings.
(02:57): US had been a AAA, which is the best you could possibly be. After that round of, of Brinksmanship they lowered our US government rating to AA. Now, from a practical standpoint, it didn’t affect anything. The US Treasury still considered the world’s safest investment, but still it was very symbolic for them to lower that that treasury rating. So we’ve seen this we’ve seen government shutdowns in Clinton Obama, Trump administration over this, this debt by the government continuing to spend money that it does not have. Occasionally the, the shutdown bleeds over into this debate over the treasury default. And at the end, I’m going to tell you, I guess, kind of give you the punchline upfront.
The Likelihood of Default
The reality is the likelihood of default is almost zero. And, and I’ll tell you why and, and different steps, but in the lead up to it, of course, everybody wants to throw that out there to try to one up the other side.
(04:06): You know, we can’t default. You’re making a default, it’s your fault, you know, those type of things. But at the end of this video, I’ll tell you why. That’s really from a practical standpoint very, very unlike based. I would say also that when we look at the, the actual problem there’s several several things to look at. But essentially, if you break it down, and one thing is we’re spending money as a country that we do not have. And I’m going to share my screen here. I have a, a chart to show you that illustrates this. This is taxes and government spending, this, this top chart here. And by the way, this is courtesy of Ned Davis research, which is going back to what I was saying, you probably never heard of it. It’s a very expensive research service that deals in facts.
(05:02): There’s not a lot of opinion. There’s no opinion page with Ned Davis research. They provide a lot of facts. They provide a lot of graphics and things like that. And that’s kind of a really good source of information that, that I use. But anyway, you can see government spending as a percentage of G D P. And you can see this spike here in Covid. And this goes all the way back to 1947. So this is not a problem of you know, the MAGA Republicans or Joe Biden or anything. This is a problem that’s been going on for a long time. Our federal government has been spending way too much money, spending more money than we have. Let’s face it, if you or I as individuals since 1947 and spending money that we don’t have we would be most likely in jail by this point certainly bankrupt and not be able to borrow more money.
(05:58): So this is not you know, reflective of the people necessarily. Today. It’s a long-standing problem that is not that is not getting any better. You can see here at the bottom, clip surplus is a percentage of GDP only. Very briefly, we’ll, back in the post-war era, there were several years where we, we had a surplus. This was in the, the Clinton years. Newt Gingrich was Speaker of the House, and they came together with Democrats and Republicans, and ran and a number of years here with spending surpluses. It’s gotten worse over the years. You can see the downward trend here. And then in, in Covid. And since then, we’ve really blown the budget out under both Democrat and Republican administration. Anyway, that is the that, that’s the problem that, that we’re facing. The other thing is, of course, our, our national debt to fund the, so what I showed you was the year by year deficit, spending more money than we bring in.
(07:04): And I don’t wanna go back to the chart, but on the top clip, it showed that the percentage of tax is a percentage of GDP. And so the problem is not a tax situation is every time we raise the tax, we just raised the spending. And so it’s just that fiscal discipline is lacking in Washington has brought us to this this situation. So, okay. So we know the problem.
We’ve Been Here Before
We’ve been here before 2011, multiple times throughout the years. We’ve been here before. We know what’s causing the problem. What are markets currently saying out there today? So, when we look at the degree of panic in the market, we look at different indicators in the, the credit market the bond market, which treasuries are part of the bond market. We look at what is the spread meaning, the difference between a treasury yield and a more risky security.
(08:00): And we look at as those either get bigger or shrink, tells you the relative perception of market participants as to the risk that’s out there. Currently the spreads out there do not indicate that there’s a tremendous amount of panic. The other thing in the out there, you can actually buy just to keep it kind of simple, you can buy insurance against a default of the treasury bill. You can pay money to effectively, it’s not really an insurance company, but just for this analogy, just think of it, you can pay an insurance premium to insure against the default of US treasury. And that premium fluctuates with the per market’s perceived risk of, of default. Just like when you buy insurance for your house, if you live in Florida with hurricanes and flooding and things like that, the perceived risk of the company having to pay a claim is much higher.
We’re Not Seeing Panic
(09:04): So anyway, so we look at those quote “insurance premiums” to ensure against default on the debt. And we’re not seeing a panic. We’re not seeing those rates go up significantly or, or to panic levels. So that’s a good sign. That’s a couple things. We look at the difference between secure strategies. What, what yield can you get on those versus what yield can you get on other types of securities? Interesting. In the past couple of days Microsoft and Johnson and Johnson Bonds people have been moving to those, there’s some corners of the market that perceive those to be actually safer at this point than US treasuries, which is kind of ironic. But really on the short term, as we look out at longer term rates, you know, there is some people that think there may be a missed, not a missed payment, but a delayed payment in treasury interest or redemption of principle.
What is a True Default?
(10:07): But there’s no one that, that believes that this will not be resolved. And in the long term markets will go back to somewhat normal functioning. Now, as we saw in 2011, there may be permanent damage to the reputation of the Treasury. But anyway, the point is, the signals right now that the, the stock market is another signal we look at. If we expected a, a true treasury default, and by the way, when we say treasury default, the USA’s 34 trillion, I think it is in debt, there’s three four 4 trillion, and that’s a giant number. But it’s not like on, you know, June 1st, which is what they’re calling the X date, the date the treasury will run out of money, that all of a sudden, all 34 trillion will be in default. That’s just not the way it works. Well, what happened is, any, any treasury maturing on June 1st, if the Treasury didn’t have any money to pay those investors back, that’s what’s meant by a default.
(11:12): No one is suggesting that all of a sudden, all 34 trillion of the US debt is going to become a bad debt anyway. So back to the, the signals that we’re seeing stock market continues to recover which is a positive sign. If, if the markets and, and participants felt like there was going to be a massive default in the debt, it was obviously plunge the US and the world into a massive recession, corporate earnings would collapse. You know, the whole economy would be in turmoil. We just don’t see those signals out there.
Now, we could all have our heads in the sand and, and be oblivious to the problem. Certainly that is a a possibility. I think it’s a very remote possibility. So right now, the signals out there do not indicate any sort of major disruption to, to the markets. Okay, what is the plan and, and how, how is this not maybe as big of an issue as, as people are making, as the politicians are making it? Number one, as I said, we’ve been here before: government shutdowns. The, the debt crisis in 2011 and Wall Street, the people that trade the security so that the Treasury creates, you know, they say, Hey, we need to raise money for, to pay our bills. And so they say, we’re going to offer, you know, $50 billion worth of treasury bills next week. And the Wall Street participants, banks investment institutions, Goldman Sachs, you know, bank of America, you know, worldwide, they bid on those treasures.
(13:03): They say, okay, we’ll buy, you know, 5 billion or, or 500 million of those treasuries. And we’re willing to, to accept those. And we want a 4% interest rate. The market actually sets the interest rate for those securities. And so that’s how the treasury raises money. They put it out for auction. And Wall Street banks, governments, they, they all bid on these securities and they buy them when they mature. Most people own these treasury securities through some sort of brokerage firm, and they trade through the mechanisms of, of Wall Street. And so Wall Street and the big investment banks and the security, the s e c what’s called sifma the Securities Industry Something Association. It’s a group of all the big investment banks and people that trade and securities, they’ve all been planning for this. They had a plan back in 2011.
(14:06): They have a plan today. And essentially what happens is if, for example, on June one, a treasury comes due and the treasury says, Hey, we can’t, we don’t have the money right now to pay that. There is a plan on how to handle that by the Securities Dealers Association to prevent panic and confusion. They have a series of steps set up. They have sort of, you know, hotlines or backbone, if you will, between all the different major participants to coordinate to make sure that there is no panic in the markets, and that that plan is in place. They’re, they’re re rehearsing it, so to speak. They’re meeting so there is a plan in place if the treasury has to delay interest payments or principal payments by, by a day or two. And frankly, that to me is probably the worst case scenario at this point, if they bring this to its ultimate brakeman.
There’s A Plan In Place
(15:10): But there’s a plan in place to prevent panic in the market. So that’s number one. There, there is a plan by the market participants to, to handle that situation. I think beyond that, there are many alternatives to actually defaulting on the debt. It kind of pains me when, when I hear politicians of both sides, as well as our own treasury secretary, sort of stoke the fires of this default. The reality is the treasury has the ability to issue treasury bills up to a certain dollar now, and they’re maturing all the time. They’re issuing them all the time. And maybe it’s a bad analogy, but I’ll just call it kind of a Ponzi scheme, is if there’s a bond maturing, it’s going to lower the debt limit. Okay? So if there’s, you know, a a billion dollars worth of treasuries maturing tomorrow then the treasury has the ability to issue another billion dollars after it pays that off so they can use money from issuing a new treasury to pay off the bond holders of the old treasury.
(16:24): Now, that’s where, what I was just talking about, the, the plan is there may be a day lag in that. Well, they issued the new bond to pay off the prior bond holders, but that’s a very easy solution. One that, by the way, there is actually a plan for that. There was a plan in 2011 for that. And there’s no reason to believe that, that the people running the treasury today and the Federal Reserve do not have that same plan in place.
So that’s number one. You can simply keep rolling the debt over reissuing new securities to pay off the old bond holders. Very simple.
Number two, the Social Security payments. That’s another one that the boogeyman that, you know, seniors are going to be left without their payments. By the way, just kind of a side note I was reading today they’re the big banks, JP Morgan, bank of America, all those big banks have already agreed and already have a plan in place to essentially advance Social Security recipients their payments on a, on a auto, you know, there are an auto payment with the assumption that they’ll get paid back from the treasury at at some point, just kind of a thing I was reading this morning.
(17:50): So everybody is, is looking for solutions for this. But back to the Social Security. So the way social security works is, you know, people that are working like, like a lot of you, like me from our paychecks money is withheld from our paychecks. And that money is deposited into the Social Security Trust fund and is invested in treasury bills. That’s what hap treasury bills, treasury bonds, that’s what it’s put in treasuries in the Social Security Trust Fund. The Social Security Trust Fund is allowed to redeem those treasuries in order to pay for social security benefits. And it’s the same kind of mechanism for regular treasuries, is when they redeem ’em to pay the benefits out, they’re allowed to issue new ones to replenish those treasuries. So kind of the same thing there in the Social Security trust fund, they can reissue treasuries to pay for the, for the Social Security benefits.
(18:55): So that also is somewhat of a strawman argument. There’s a mechanism in place. It may cause like I said, a, a day or two lag to, to execute that, but it is legally permissible, and it is a relatively straightforward process. Kinda like you know, if you refinance your house, you exchange your old mortgage for a new one, it may be seamless to you, but there’s actually sort of a gap in there. While the new mortgage company takes over the old and kind of the same thing, they reissue new treasuries pay off the bond holders that have the existing treasuries. Same thing happens, can happen in the Social Security Trust fund. Number three is the executive branch. President Biden and the Treasury Department are legally required to pay the debt. They don’t have a choice, so they can’t just say, oh, well, Congress didn’t do this or that, they have to pay it the debt, and they have to pay the social security bills.
(19:59): If that means shutting the government down, if it means not paying government workers, if it means not doing certain things, they have to do that. But the key thing is they are legally obligated to pay that debt, and there is money to to, to do that. You just kind of have to shift things around. There’s actually a Supreme Court decision back in, I think it was 1974 or somewhere in the early seventies that that confirmed that the executive branch has the ability to move funds around in order to pay its legally obligated debts, which include the, the treasury debt and social security payments. So there’s, there are alternatives to default. Number one, they’re, they’re good alternatives. They’re, they’re plans for these things. They’ve been in place for a while. They’ve actually been executed in previous government shutdowns.
(21:00): So once again, the prospect that we default on 34 trillion of debt, June 1st is, is zero. And I’d also like to leave you with one more chart here if I can. What I have here is a chart of the S&P 500. So the S&P 500, just to refresh everybody is an index of the 500 largest companies in the United States. And what I have, the time period I have selected here is September 1st, 2011, which is approximately the date of the 2011 debt crisis when the US Treasuries were downgraded from AAA to AA. The sort of mirror situation of what we’re going through today. And this is the return of the stock market since that time. And I’m going to go over here to the end and put my cursor here to today.
(22:19): If you look on the far left hand side of the screen, I can’t move my cursor because then it changes. But you’ll notice if you can see it over there on the far left hand side, the percent change between that date and today is 323%. So since the last debt crisis the let me get back to lemme get back to stopping share. So since the last debt price of this time, the S&P 500 returned 323%.
The Takeaway: Don’t Panic
I believe that this debt crisis will be resolved. If you are a long-term investor, there’s no reason to panic. If you own treasury bills or bonds, there’s no reason to panic. I believe that any disruption in the markets will be relatively short-lived. Now, long-term we still have to solve the problem of spending too much money.
(23:27):Unfortunately, I can’t solve, I mean, I could solve it if I was in charge, I could solve it. But our politicians do not seem to have the will at this point to solve that issue. Maybe they will after this, maybe they won’t. What I can assure you that is wherever there’s opportunity in the world whatever asset class we have to invest in, whatever country we have to invest in, unless the entire world collapses, we will find places to invest to make money for you to provide security for your retirement or whatever your goals may be.
We’d Love to Talk to You
So if you have any questions on this please let us know. Happy to talk about it. And I’m, as I’m sure you are, I just hope and pray that our, our leaders there in Washington can come to some sort of agreement over the weekend so that we can come out of the Memorial Day weekend with this in the rear view mirror, focus on getting out of high inflation, focus on avoiding a recession and get back to some normalcy. So thanks again for listening. I enjoyed it. And as always please let me know if you have any comments or questions. We’d love to talk to talk to you. Thank you.