We have a debt ceiling deal.
And the deal is there is functionally no debt ceiling until January 2025.
When this drama all started back in January, I called it “a fake debt ceiling fight.”
Well, the fake debt ceiling fight got us some fake spending cuts!
In effect, the US government can borrow an unlimited amount of money until after the next presidential election.
The plan also includes “spending cuts.” Here’s how the New York Times explained it.
It would cut federal spending by $1.5 trillion over a decade, according to the Congressional Budget Office, by effectively freezing some funding that had been projected to increase next year and then limiting spending to 1 percent growth in 2025, which is considered a cut because it would be at a lower level than inflation.”
House Speaker Kevin McCarthy bragged that this was “the LARGEST SPENDING CUT that Congress has ever voted for in history.”
But when you strip away all of the rhetoric the spending “cuts” in this debt ceiling deal are actually increases in real spending. That means the enormous budget deficits will continue.
The fact that the “largest spending cut” ever is going to increase spending tells you everything you need to know about Washington DC.
And the sad reality is there is no way that the federal government spending will be contained by this deal. The spending limits will last right up to the moment the government comes up with some new emergency to justify more spending.
So, like, next week.
But don’t worry. Congress just handed Uncle Sam a credit card with no limit. He can afford it.
Here’s the ugly truth. Even with these “historic spending cuts,” total spending will still be more than a trillion dollars above where it was in 2019.
And Congress had the gall to name the bill “The Fiscal Responsibility Act of 2023.”
It’s too bad government isn’t held to “truth in advertising” standards.
Keep in mind, we had a big deficit problem long before the pandemic. In FY2019, the Trump administration ran a $984 billion deficit. At the time, it was the fifth-largest deficit in history. Through the first two months of fiscal 2020 — before the pandemic came to America — the deficit was already 12% over 2019’s huge Obama-like number and was on track to eclipse $1 trillion.
So, with this deal, we’re still doing that and then some.
And this deal doesn’t even address non-discretionary spending such as Social Security and Medicare. Mises Institute executive editor Ryan McMaken summed it up this way.
What all this really means is that discretionary spending (which is generally around $2 trillion in miscellaneous and military spending) will continue upward without even a meaningful pause. Meanwhile, mandatory spending—such as Social Security, Medicare, and Medicaid is in no danger of actually going down. At a minimum, we can expect annual increases of $60 billion or more each year in the near future. That’s the most ‘thrifty’ scenario. After all, it’s only a matter of time until there’s a recession and thus a need for ‘stimulus’ and bailouts. Or, Washington may decide the US needs another full-blown war. At that point, all bets are off when it comes to spending.”
Currently, the Biden administration has been spending at around a half a trillion dollars per month clip. In April, the US government blew through $426.34 billion. Thanks to all of that spending, coupled with declining tax receipts, the fiscal 2023 budget deficit already stands at just under $1 trillion.
So, this great deal means we’re just going to keep doing that.
Now, the CBO claims that “as the deal stands today,” there will be about a $1.5 trillion reduction in the deficit over the next decade. That sounds pretty awesome until you realize that is just $150 billion per year and amounts to less than 5% of the projected deficits. And I have to reiterate that the deal won’t stand as it does today.
On top of that, the CBO and other pundits analyzing the plan are including all kinds of unrealistic rosy economic projections. If you use a more realistic set of assumptions, the deficits are just going to get bigger.
The US government already faces a revenue problem. Last year, strong tax receipts helped to paper over the spending problem. The federal government enjoyed a revenue windfall in fiscal 2022. According to a Tax Foundation analysis of Congressional Budget Office data, federal tax collections were up 21%. Tax collections also came in at a multi-decade high of 19.6% as a share of GDP. But CBO analysts warned it won’t last.
We’re already seeing that downward trajectory. Compared to April 2022, tax receipts were down 26.1% in April 2032, according to the monthly Treasury statement.
And government tax revenue will decline even faster if the economy spins into a recession.
This budget deal is the ultimate in “kick the can down the road.” All of the politicians in DC can pretty much continue business as usual without worrying about any kind of borrowing limit until after the next presidential election. Meanwhile, the public assumes that everything is fine because “they got a deal done.”
But as I have explained previously, everything is not fine. This deal doesn’t solve anything. Now, the now the real problem begins.
According to an analysis by Goldman Sachs, the US Treasury may have to sell $700 billion in T-bills within six to eight weeks of a debt ceiling deal just to replenish cash reserves spent down while the government was up against the borrowing limit. On a net basis, the Treasury will likely have to sell more than $1 trillion in Treasuries this year.
Who is going to buy all of those bonds?
The market may be able to absorb all of that paper, but it will almost certainly cause interest rates to rise even more as the sale drains liquidity out of the market.
In effect, as the Treasury floods the market with new debt, bond prices will likely fall in order to create enough demand for all of those Treasuries. Bond yields are inversely correlated with bond prices, and as prices fall, interest rates rise.
A Bank of America note projects that the anticipated post-debt ceiling bond sale would have an impact equivalent to another 25 basis point Federal Reserve rate hike.
Of course, there is no cap on how much the federal government can spend on interest payments to support the massive national debt.
The liquidity crunch will also spill over into the private bond market. The price of non-government debt instruments will have to fall as well in order to compete with Treasury bonds. That means the cost of borrowing will go up for everybody.
This is obviously problematic in an economy that is loaded up with debt and already in the midst of a financial crisis.
At some point, this unlimited borrowing is going to force the Federal Reserve to monetize some of this debt. That means a return to quantitative easing.
Even if it doesn’t happen immediately, QE is in the future. There is no other way for the market to absorb all of the debt the Treasury will have to issue to support the spending with on a credit card with no limits.
In order to prop up the bond market and keep prices higher than they otherwise would be (and interest rates lower), the Fed will ultimately have to buy bonds to boost demand. It will buy those Treasuries with money created out of thin air.
In other words, you’re going to pay for all of this government spending through the inflation tax.
So, after months of wrangling, we have fake spending cuts and an effective debt ceiling of infinity.
This should go well.
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