Iron Capital Insights

  • Iron Capital Insights
  • July 22, 2011
  • Chuck Osborne

A Word on the Debt Ceiling

I have put off discussing the debt ceiling for two reasons. First, because these economic issues are inherently political, and I promised not to discuss anything political this year, since I don’t like doing it and was tired of having to do so for the last few years of the economic crisis. Second, the market has been shrugging this whole thing off as political theater. Interest rates have stayed low and the stock market is hanging in there, which tells me that investors don’t believe for a second that August 2 will pass without some sort of deal.

However, I have received a question that frankly surprised me. More than one client has asked whether I believe the debt ceiling should be raised. I then realized that through all this partisan noise of political negotiations and rumors that no one in our modern media has really taken the two seconds it takes to explain what this is all about. Ultimately the political debate is about two diametrically opposed visions of how a country should be governed: should we have a small limited government that does little more than protect personal property rights, or should we have a large and involved government that controls most every activity in our lives?

However, that isn’t fundamentally really about the debt ceiling. The debt ceiling just provides an excuse, some political leverage to have this ongoing debate which has been occurring here since the founding of our country and elsewhere in the world for much longer. That debate will not be settled by August 2; in fact, it never will be completely settled. The debt ceiling will be raised, however, and I can tell you why I am sure of that, and based on actual market activity, the market is sure, too.

The debt ceiling is a farce – we blew by it a long time ago. On or around August 2 when the philosophical posturing finally gives way to pragmatic reality, we simply will be admitting that we blew past it. The debt ceiling does not refer to actual debts or obligations the way real people and real companies have to account for their debt. If you and I were to create a personal balance sheet of our debts, or liabilities, we would not just include obvious things like our mortgage or car loans. We also would include bills received but not yet paid, credit card balances, and any promised future payments. When corporations prepare their financials they must list as liabilities their accounts payable and promised benefits such as pension or healthcare benefits that they have obligated themselves to pay some time in the future.

Government does not work that way. The debt ceiling refers solely to the amount of Treasury bonds the government can issue. If the government had to report its actual financial condition under the same accounting rules as corporate America, the $14 trillion ceiling would have been surpassed a long time ago. On August 2 we do not reach a date where our government can no longer make new commitments; we reach a date where our country can’t fulfill the commitments it has already made. That is unacceptable.

It is good that we have the debate on what our government should actually look like, and we need to continue that debate as we have throughout our history. However, the real time for that debate if before we make commitments, not when the bills come due.

This debt ceiling is a political mirage, an arbitrary rule which easily can be changed. The bond market is clearly signaling a willingness to buy more U.S. government debt, so we have not come close to a real ceiling. However, the lesson of Greece, Italy, Ireland, Portugal and Spain is that a ceiling is up there somewhere. On our current trajectory we will reach it some day. It may not happen for years, perhaps not even in my lifetime, but it will in my children’s. As a father that is not acceptable to me and I hope and pray it is not acceptable to you, either.

The political debate will continue and ultimately the ballot box will decide which view carries this day, but in the interim the government will raise the debt ceiling. There is no choice.

Chuck Osborne, CFA
Managing Director