According to the Treasury's daily statement for the last day of November, total public debt subject to the Congressional debt limit of $15.194 trillion is now $15.067 trillion—only $127 billion (less than 1%) away. At the current monthly run rate of around $90 billion, the ceiling is likely to be reached early in 2012.
The debt agreement from August of this year empowers President Obama to raise the limit by another $1.2 trillion. However, that only buys about an additional 13 months, depending upon how economic and financial variables shake out in the quarters ahead, and the sequestration feature of the law is designed to offset every dollar of that increase beginning in 2013.
In other words, unless federal politicians can do some slick backstepping in the next 13 months—which the prospect of an election year makes all the more challenging, I think—then the enlarged federal deficits that have made our economy the envy of the austerity-smitten world of late will rapidly contract, with severe financial and economic consequences to follow, including even higher debt-to-GDP levels (unless, of course, the private sector makes an unexpectedly swift return to health and takes the credit baton in hand once again—an outcome we don't advise holding one's breath for).
It's important for investors to disinguish between a self-imposed U.S. credit event, such as the debt ceiling impasse of this summer, and a potential one in 2012 or 2013, and the almost irrelevant rating agency pronouncements regarding U.S. creditworthiness. Besides inflation exceeding a socially desirable level, there is no constraint on the ability of the U.S. government to honor its financial obligations (other than self-imposed political errors).
Next, it's important to make an accurate assessment of the types of assets likely to hold up in a worst case environment. Although it may sound counterintuitive, both the U.S. dollar and U.S. Treasuries would be attractive in a self-imposed, austerity-induced deflation -- their supply would be shrinking at the same time demand for them is increasing.
Perceived safe havens such as precious metals might get some support, but if deflationary pressures aren't forcefully reversed, they are likely to eventually succumb to nominal price pressures like everything else, including any non-sovereign form of credit denominated in U.S. dollars (this includes corporate and non-U.S. government debt, both domestic and foreign). Even emerging market and other bonds issued in local currencies could suffer due to exchange rate fluctuations if the U.S. dollar becomes increasingly scarce.
An especially interesting area to look at (either to avoid or to bet against) would be Yankee bonds (bonds from foreign issuers denominated in U.S. dollars), which have seen exploding issuance in Latin America and Asia in recent years. So-called dim sum bonds from Chinese issuers could also experience some rough sledding.
That's the playbook for a worst-case scenario (which happens to be the outcome that a large number of economic and financial professionals are pulling for, simply because they don't know any better). But federal politicians seem to be intent on steering their way out of this mess without causing undue pain to themselves and the American people (perhaps in that order?).
Ironically, a recession in 2012 might be just the cover they need to escape the trap they've foolishly laid for themselves and the rest of us (in similar fashion, we predict that the eurozone won't adjust its operating framework and philosophical mindset until Germany's impending recession gets deep and painful enough). At this point, there's no way to know what the outcome will be. But it makes sense to have well thought out plans in place for the most impactful scenarios.
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