Debt Ceiling Debacle Strategy: Do Nothing

Includes: AGG, DIA, IYY, QQQ, SPY
by: Tim Ayles

"Warning of dire financial consequences, the White House urged Congress today to raise the national debt ceiling before the Government runs out of authority to borrow money this Friday.

”We cannot overestimate the effect of such a dereliction of duty,” the President’s spokesman, said.

"But a number of conservative Republicans refuse to heed the Administration, and White House legislative strategists say they do not have the votes to assure passage of such a measure."

Sound familiar? That was written in 1987. The Republicans were doing that to their own president. Lest you Democrats think this mess falls only on the Republicans:

“The Republican-dominated Senate voted tonight by 64 to 34 to raise the Government’s borrowing authority to more than $1 trillion for the first time in history. The vote to raise the debt ceiling, to $1,079 billion, will allow the Government to start its new fiscal year Thursday with sufficient funds in its coffers to pay its bills ...

"Although the routine increase in the debt ceiling was essential to meet Government obligations already incurred, the vote is traditionally delayed to the 11th hour, with the minority party accusing the party in power of spendthrift ways.”

That quote may surprise you. It comes from the New York Times, Sept. 30, 1981, defending President Reagan and blaming the Democrats in Congress for playing games with the debt ceiling.

I must admit, I need to thank both political parties for making me more valuable to my clients as they continue to spew fear and loathing on the airwaves of America. As an investment advisor, I have clients who are watching the debate, and becoming increasingly worried about the fallout from the impending "crisis." Many have contacted me wanting to know my thoughts and asked me for my "plans" the moment America "defaults." One wanted to sell everything and hold cash. Another wanted to own almost all gold and gold stocks. That's about as opposite a reaction as you can have.

What do I plan to do in order to protect them from our politicians and America's impending "default"? Nothing.

And that is probably what makes me most valuable to my clients, most of whom would probably read the headlines and sell everything, never to get back into any investment out of fear. In the long run, they would hurt themselves dearly, even though they might be right about this "trade" in the short run.

America defaulting is not the same as your neighbor losing his job and not being able to pay his bills. It's more like Warren Buffet signing a 12 month contract to pay for dancing lessons, then realizing he has a personality clash with the instructor who was rude to him. He then decides to not pay, and the dance instructor reports him to the credit bureau as "defaulting" on his obligation. It's not that he can't pay the bills, it's just that he has decided to send a message by not paying.

You see, the federal government in America cannot run out of money. The reason for this is they dictate what money is, and then create it if needed. Your neighbor who lost his job does not have that ability. In fact, the city and state that you live in does not have that ability. Your neighbor needs to offer up his labor in order to get money. Your city and state need to tax you on your labor in order to get the money they need, or they need to beg rich people to lend it to them.

The federal government? They are not required to do either. They just spend what they determine, by force, is to be used as money. All this bickering back and forth on the airwaves is nothing more than politics at its worst. Each side is using something meaningless, the debt ceiling. To scare the people and win their hearts and minds to their side in order to get votes in the next election. It's disgusting.

Why should you not be worried about the debt ceiling? Simple. Federal level debt is nothing to worry about. Americans are hard wired to worry about the government debt levels, and they shouldn't. They think the government is America, and that we will somehow need to pay this debt back some day and become debt free, like paying off a mortgage. Nothing is further from the truth.

Treasury debt is nothing more than a place for people to park their money and earn interest because they don't want to take on risk investing it somewhere else. Treasury debt FUNDS NOTHING! As a matter of fact, federal taxes fund nothing. Taxes are nothing more than a drain of resources that act as a governor on the supply of money that can be moving around the economy, an inflation dampener if you will. The U.S. does not need to collect more taxes, nor do they need to call up China and beg for a larger credit line, in order to spend more money, or pay their bills. They determine what money is, and then just spend it into existence in the economy. Some will argue this is bad, and begin to talk about hyper-inflation.

I have written extensively about why I believe this is not something to worry about in the current situation. I'll let you tell me on that blog why I am an idiot. Let's get back to my tirade.

Pretend with me that we get to a point in America where no one works, ever. Everyone gets $100,000 per year from the government, which spends the money by creating it, and sets tax rates at 0%. In order to get food and clothing and housing, etc., we need to rely on foreigners to provide it for us. We can buy houses, but only if foreigners are willing to come here and work to build us our homes. They have to bring their own lumber and tools though, because we can't work cutting down trees or designing tools. We just spend. And enjoy the fruits of everyone else's labor. The foreigners work tirelessly so we can live well, and in return receive a bunch of paper with pictures of dead white men on them.

The $100,000 per person that the government creates is pure deficit spending, which becomes debt because it is not offset by taxes at all. Assuming there are 300 million Americans, the debt would increase by $30 trillion every year. Not sustainable for sure. But why? Is it because the U.S. government is "running out of money" since they cannot collect enough in taxes to pay for it? Hardly.

The reason it is not sustainable is because the world will not work for dollars they cannot use to buy something with. It is the same reason why you would not come to work for me if I promised to pay you in grains of sand. The sand is useless to you at the grocery store.

If every American does not work, then they are not producing anything on which the world could spend the dollars on. Currently, American workers are producing trillions of dollars every year worth of quality goods and services. Therefore, foreigners don't mind accepting them because they can be used to buy up the labor and creativity and production of American workers. The more we lose that, the less foreigners will want our dollars. The drop in the value of the dollar over the past decade has less to do with federal debt levels as most fearmongers will have you believe, and more to do with the rest of the world becoming more productive themselves. As the value of the dollar stays low though, American productivity will become more valuable in the world, and the cycle will continue to ebb and flow. These are long term, generational cycles mind you, but they are there.

What assurance do we have that Americans will attempt to be productive and create wealth to sell within and across our borders? Taxes. The government, who decided beforehand what money is, will tax those who want to own property, and work! If you do not pay those taxes, they will take your property and your freedom, putting you in jail. So the world can trust that America will stay productive because Americans want to make more money than the next guy so they can provide a nice lifestyle for their families. That is just human nature for most. America also offers the person with no ambition a meager existence. They will not be taxed on anything, because they do not own anything. They do not own anything, because they do not, or cannot, work. Because they are not working, they are using resources, yet not contributing to the value of America. As humans, we must not let them suffer, but we also must not let them live a life that is better than those who are contributing and exchanging their sweat and brain power to America's productive value. Keep taxes so people have incentive to work, but make them less so they are more determined to provide a better lifestyle quicker, thus creating more jobs for everyone.

Take that Democrats.

Likewise, the other side of the debate says that we must cut government spending, as if we are running out of money somehow, and if we don't, there will be a day when we go to draw on America's paycheck, and there is no money in the bank. That is just NOT the way our current monetary system works. To drive this point home, let's again pretend that I wipe out the government completely, and become dictator overnight. I no longer allow the U.S. dollar to be the currency we use in America. Only vials of sand from Stinson Beach in California can be used in exchange for goods and services. I set up armed military on the beach in order to control the money supply (think counterfeiting laws) and begin to levy taxes on your homes and other property that can be paid only in Stinson sand vials.

Where does that leave you? Well - you now have a desperate need to get your hands on some vials of sand, or risk losing your property and freedom to me. If I don't first spend those vials of sand buying the production and labor of the union first, there would be no sand in the economy to spend. Notice I did NOT need to tax you first in order to get my hands on the sand, nor did I need to call China and ask them if I can borrow their sand, I just spent what I determined the currency to be. (Think deficit spending)

Now you and your family have vials of sand that have value only because everyone is trying to get their hands on it to pay taxes and stay out of jail. You also have freedom to work harder than the other guy, and get ahead by getting your hands on more vials of sand, which in turn allow you to buy more products and services that are produced by others trying to get their hands on that sand so they can get ahead. (Think free market capitalism)

Carry this thought out a little further. Let's pretend that I only issue 1,000 vials of sand, because a certain political group says I am going to run out of my sand. They scare me into thinking I will get voted out of office, so I concede and limit the vials to 1,000. Those 1,000 vials make their way around the country and world as people decide to spend them on things they want and need. As they become harder to get your hands on, you start to ration and only spend it on things that keep you alive, like food. Since you need to eat everyday, all of your money goes only to food. Eventually, you run out of money because now all the money has been given over to the food companies. (Think Wall Street) The food companies, having all the money, begin to pressure me to do things by threatening to not give me money, nor support my ambitions, unless I give in to them. You begin to riot because you are starving, and under threat of death by mob, I concede and let out another 1,000 vials of sand. That alleviates the pain for a bit longer, until the money yet again flows to the food companies who now own 2,000 vials. As you can no longer get your hands on the vials of sand, you are no longer are motivated to work, and America loses another productive citizen who could be exchanging their labor so that others can have more options for products and services that make life more enjoyable. Government spending is a must. As the economy grows and becomes more productive and includes more and more people and countries, the economy will need more and more vials of sand that can be exchanged.

Now the food company, who owns all the vials, has nothing else to spend their money on, because demand in the economy is not there. I tell them they can put it on deposit with me and I will pay them 80 vials a year. They give me their 2,000 vials, which sucks up the entire money supply, and the economy now only has 40 vials available per year. I am not in 2,000 vials of "debt," which when repaid will truly increase the money supply. At repayment, I will unleash the 2,000 vials back on the economy, along with the interest I had been paying.

Treasuries only suck up excess money supply and act as a buffer on inflation. If you really want high inflation, have the government pay back the debt to owners of Treasuries, and issue no Treasuries ever again. Americans will have trillions in cash, and nowhere to go. Hello commodity and asset price hyper-inflation. Taking the 2,000 vials out of the market (think cash being given back to the creator of the currency in the form of Treasuries), and then slowly leaking it back out in the form of interest payments, is another moderator on excessive speculation and high inflation.

Oh, by the way, am I in a much worse financial position now that I added the 2,000 vials of sand to my four million truckloads that I have, and issued an IOU in the meantime?

Take that Republicans.

The hard part in all of this is finding the right balance of taxes and spending. When we are hurting like we are now as an economy, we need the government to lower taxes, and increase spending in order to combat deflation. You see the humor in that? Unfortunately, both parties in this debt ceiling debate get it half right and half wrong. Typical. When the economy is booming, the federal government needs to spend less and tax more, in order to combat massive inflation.

When politicians are using the worthless debt ceilings to scare you into taking sides and changing up your long term investing goals, you should do nothing.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.