How Will the Impending Debt Ceiling Crisis Affect Gold & Silver Prices?
Unless you completely ignore the media, in which case you might be better off, you may have noticed that we have an impending debt ceiling crisis on our hands. As usual, this issue has become political with the left interested in raising the debt ceiling without limitation while the right is insisting on certain cuts and limitations on future spending.
Furthermore, Janet Yellen, the Treasury of the Secretary, has been warning about a debt default and the looming “X” date of June 1st, which somehow magically has been pushed back to June 5th.
The last update at the time of this writing indicates that McCarthy and the Biden Administration have agreed to terms in principle, but the bill still needs to be drafted and approved by Congress.
Many of our customers are concerned about threats of a downgrade to the U.S. debt rating, a potential debt default, and the ability of the United States to pay its bills in the future. There is also talk about the Federal Reserve’s role and ability to intervene in the current environment. In this article, we’re going to discuss some of these issues and speculate on the future price of gold and silver.
To begin with, let’s address the current debt ceiling, which at the time of this writing is $31.4 trillion. For those of you keeping score at home, we ended 2022 with an estimated national debt of $31.4 trillion, and at the time of this writing are quickly approaching $32 trillion. If we have spent in excess of $400 billion above the debt ceiling, obviously certain concessions have been made by the Treasury to free up some funds.
While a debt ceiling is good for America, as it limits the amount of money that the government can spend on its pet projects, the reality is that we have had many debt ceiling deadlines in the past and somehow have always managed to raise the limits. In this writer’s opinion, the political theater and warning of a debt default is a scare tactic, as we all know that the government always kicks the can, ultimately making the next financial crisis worse than it could have been.
Word coming out of the White House and McCarthy’s office is that the debt ceiling will be raised by approximately $4 trillion with a reported $50 billion on spending cuts. Spending will increase by 1% in 2025, and of course, future administrations aren’t beholden to the terms that will ultimately be reached in this bill. At the end of the day, the nominal spending cuts will have a limited impact on the country’s financial position, which continues to deteriorate as we spend more money than the government collects in taxes.
In recent years, the annual deficit has been $1 trillion or more, with much of this spending occurring post Covid-19. In other words, we’ve been running up massive deficits at a time when the economy is supposedly running on all cylinders. Unfortunately, the reality is that the economy is on shaky ground. We’re already seeing major cost cutting measures by some of the largest employers in the U.S. They’re preparing for slower growth and weaker earnings, which will result in less tax revenues to the government, thus requiring more spending and higher deficits.
Debt to GDP Ratio
At the time of this writing, the debt rating of the United States is AAA, which is among the highest in the world. However, it’s not the highest rating available and hasn’t been since our debt rating was downgraded in 2011 by the major credit rating agencies. Even so, the U.S. dollar has continued to remain the world’s reserve currency, although, with countries moving away from the dollar, frequently referred to as de-dollarization, at some point, the dollar will no longer be the preferred currency for global trade.
One way to measure thehealth of a nation is by looking at its debt to GDP ratio. According to the World Bank, a debt to GDP ratio above 77% is the tipping point. This is for developed nations, such as the United States. The threshold is lower for emerging markets at 64%. According to the study, each additional percentage of debt above this threshold costs .017 percentage points of annual growth. This study is consistent with an article we read a while back stating that a 90% debt to GDP ratio is the point of no return.
According to the Bureau of Economic Analysis (BEA), total U.S. GDP in 2022 was $25.46 trillion. While this is an impressive figure and surpasses the rest of the world, unfortunately, so does our debt, which stood at $31.4 trillion at the end of 2022. If we take the end of year figures for 2022, we arrive at a debt to GDP ratio of 123%, which tracks pretty close with this website, which lists our debt to GDP ratio at 128%.
Our banana republic-type financial position puts us in 12th place for the most indebted nation in the world as a percentage of GDP, on par with Bahrain. Most folks couldn’t find Bahrain on a map. Fitch, one of the leading credit rating agencies in the world, lists Bahrain’s debt rating at B+. As you may recall, our current debt rating is AAA, albeit with a negative outlook. This is a full 5 levels above Bahrain’s debt rating, which has enabled us to issue bonds at lower interest rates, allowing us to continue to incur massive deficits without substantially impacting our economy.
To help put things into perspective, as of this writing, Bahrain’s 5 year bonds are yielding 6.291%. This compares to a yield of 3.938% for U.S. 5 year bonds, which is nearly 60% lower than Bahrain’s bonds. If we didn’t have the world’s reserve currency and were evaluated strictly on our financial situation, it would be difficult to service our massive debt of over $31.8 trillion. In fact, if our bond yields rivaled Bahrain’s at 6.3%, an incredible $2 trillion would go solely toward servicing our debt payments, which amounts to over 40% of annual tax revenue.
In a span of less than half a century, the U.S. has evolved, or maybe more appropriately devolved, from the world’s largest creditor nation to the world’s largest debtor nation. We rely on the rest of the world, including the Federal Reserve, to be able to spend beyond our means, but unfortunately the Federal Reserve’s hands are tied – at least as it respects the current debt ceiling crisis.
Federal Reserve Intervention
We’ve heard some commentators over the past couple of months talk about the Federal Reserve’s ability to print money, which enables us to continue to incur incredible amounts of debt. While this is certainly true, as is evidenced by their bloated balance sheet of over $8.4 trillion, they’re unable to assist with the debt ceiling crisis, as this is a legal limit imposed by Congress.
The debt ceiling was introduced by Congress is 1917 and according to the Treasury’s website, has been raised 78 times since 1960. Granted, we’ve always raised the debt ceiling, but in some instances, the government was shut down for a period. In fact, it has happened more frequently than you would think with 21 shutdowns at last count. However, the shutdowns have been short-lived with the longest and most recent clocking in at 34 days back in December of 2018. For those of you who may remember, some government employees were furloughed, state parks were shut down, and some payments may have been slightly delayed, but eventually everyone was made whole, including backpay for furloughed government employees.
Even if the Federal Reserve was able to intervene before the debt ceiling is eventually raised, they may not be willing to do so, as they’re continuing to try and stoke inflation by raising interest rates and reducing their balance sheet. While they’ve had some nominal success reducing the CPI, inflation has remained stubbornly high with talks of at least one more rate hike in June. If that occurs, the Federal Funds Rate will be in the 5.25% – 5.5% range, which will not only exceed the inflation rate, but will be at its highest rate since 2007, which was just before the Great Recession of 2008 – 2009.
Once the debt ceiling is raised, the Federal Reserve isn’t likely (at least initially) to be a buyer of newly issued debt, which could have a negative impact on the government’s ability to issue bonds at low interest rates. While institutions and the general public can be counted on to soak up some of the debt, considering the current de-dollarization trends, we don’t expect enthusiastic buying from foreign central banks.
Is Government Debt Default Inevitable?
The Biden Administration, Janet Yellen, members of Congress, and many folks in the mainstream media are running with the narrative that the government will default on its debt obligations if we don’t raise the debt ceiling. This is an issue that’s worthy of further analysis.
In 2022, the U.S. government received approximately $4.9 trillion in tax revenue compared to roughly $6.3 trillion in expenditures. The expenditures are broken down into three categories, including mandatory ($4.1 trillion), discretionary ($1.7 trillion) and net interest ($475 billion). While net interest payments on our debt have likely increased since last year, with the Congressional Budget Office (CBO) estimating 2023 debt servicing payments at $663 billion for fiscal year 2023, there’s still plenty of revenue to make our debt payments.
However, this requires us to prioritize payments for other programs, cut spending or raise taxes. Considering that neither side of the aisle is interested in making significant cuts, nor is a tax hike the year before a presidential election politically viable, the most likely solution will be to prioritize payments. This may result in some payment delays, but there’s not a great likelihood that we’ll default on our obligations.
If history is any indicator, even if the debt ceiling isn’t raised by the June 5th deadline, it likely will be within a month or two of the deadline. This isn’t likely to cause the economy to come to a grinding halt, as financial commentators claim. It will just be inconvenient for some folks who are more reliant on the government than others.
With net interest payments consuming only 10% of the budget in 2022, there’s little chance of default. However, if 2023 debt servicing projections are correct, debt payments may consume as much as 13% of revenues this year, which will likely only increase in the future. We believe that net interest payments of 20% – 25% of annual revenues could be a potential tipping point, which at the pace we’re going, could be reached in a matter of a few short years. Not only are interest rates increasing for new debt issuance, but existing government debt will be maturing and will need to be refinanced at higher rates. Certainly, much higher than the 1.5% effective rate that we paid in 2022.
Gold & Silver Prices in the Event of Default
We’ve talked a bit about the likelihood of a debt default. While we believe that a default is likely at some point through an outright default or a default through inflation, we don’t believe that it’s imminent and won’t likely be caused by the debt ceiling crisis – even if it goes on longer than expected.
However, for purposes of discussion, let’s assume that we’re going to default on our debt obligations. If we do, there will be a mass exodus of the dollar, devaluation of the currency and skyrocketing interest rates. Considering that gold and silver have an inverse relationship to the strength of the dollar, we would expect for gold and silver, or for that matter, all precious metals to skyrocket in this scenario. Needless to say, if you feel a debt default is inevitable, then now is the time to back up the truck and load up on gold and silver.
You may be surprised that we believe a default is inevitable. You’ll better understand why we believe this is likely the case when you consider all of our debt obligations – not just on balance sheet debt. While the official on the books debt is approaching $32 trillion, the present value of the unfunded liabilities for programs such as Medicare, Medicaid, and Social Security is estimated to be $150 – $300 trillion. This unfortunately is an insurmountable level of debt that can’t possibly be paid.
Considering that outright default doesn’t appear to be politically viable, especially while the U.S. dollar continues to enjoy its status as the world’s reserve currency, that leaves us with default through inflation. While the Federal Reserve is currently pursuing a tight monetary policy, the reality is that it’s likely going to be short-lived, as inflation is the only acceptable alternative to outright default.
While the rise in gold and silver prices won’t be meteoric under a default through inflation, they will continue to rise as the dollar depreciates relative to other currencies and in response to monetary inflation. To put things into perspective, when the economic crisis began in 2008, the Federal Reserve’s monetary base was $800 billion. A mere 15 years later it has increased by a staggering 10.5 times! A decent bit of the increase in the balance sheet was in response to Covid-19, but by the time the next recession rolls around and the Federal Reserve reverses course, we’ll likely see the balance sheet jump to $10 trillion or more.
In conclusion, we’re quickly approaching a debt ceiling crisis that many in the media and in our government are claiming will result in a debt default. If the Treasury runs out of money without a corresponding increase in the debt ceiling by June 5th, we’ll need to prioritize our bills. This might cause some payments to be temporarily delayed but considering that debt servicing payments are only 10% – 13% of tax revenues, these expenses can be prioritized over discretionary expenses.
Still, the United States is in a precarious financial situation. Our debt to GDP ratio is the 12th worst in the world, on par with Bahrain who has a B+ debt rating. We have benefitted from the dollar as the world’s reserve currency, but countries are beginning to move away from the dollar, which will cause it to weaken relative to other foreign currencies.
As a reminder, the Federal Reserve monetizes our nation’s debt, but Congress needs to increase the debt ceiling before the U.S. Treasury can issue more debt. Even if Congress approves an increase in the debt ceiling, there’s no guarantee that the Federal Reserve will step up and monetize all the new debt – at least right away.
At the end of the day, default is inevitable. If slow and painful through inflating our debt away, gold and silver will rise, but at a slower pace. However, if we choose to rip the band aid off and default on our debt obligations and ideally adopt a gold-backed currency, we’ll be able to clear all the malinvestments and start with a clean slate.
As is the case with everyone else, we’ll be curious to see how everything plays out. Ultimately, kicking the can will make the next financial crisis that much worse. As a nation, we need to get our financial house in order by passing a balanced budget, reducing spending, reducing or eliminating entitlements, adopting a gold standard and reestablishing the dollar as the world’s reserve status and the preferred currency for international trade.
In the meantime, protect yourself and your family by buying gold and silver. If you’re new to investing in gold, we suggest checking out this article on overcoming the fear of making your first investment.
Give the coin experts at Atlanta Gold & Coin a call today at 404-236-9744 to reserve yours.