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FOMC Minutes and Debt Ceiling

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While headlines are dominated by the brinkmanship over spending playing out in Washington, the Fed will release the minutes from the last FOMC meeting. This could provide markets a little break, as attention focuses on what’s coming after the debt ceiling issue.

The current assessment by the US Treasury is that it will run out of money on June first (or close thereafter), in the so-called “x-date”. By then, the issue of the debt ceiling needs to be resolved. The Fed won’t meet until two weeks later, meaning that the interpretation of the Fed minutes won’t include the current issues that are getting all the headlines.

So, default?

There are a couple of issues around the debt ceiling to clear up. The first is that an important part of the negotiating tactics involves saying the deadline is sooner than it is – on both sides. The House has been implying that it would take at least a week to pass any deal that is made, raising the urgency of finding an agreement. The White House (through the Treasury) has warned that the date is “as soon as” June 1st, but not committing specifically as the last day possible. So, the negotiations could go on to the very “limit” and even beyond, which could keep riling up the markets.

The other issue is that if the US does hit the “x-date”, it doesn’t mean that the government falls automatically into default. All it means is that the General Treasury Account (GTA), which is like the government’s current account, will go down to zero. In order for a default to happen, the government would have to fail to make an interest or principal payment on any of the outstanding loans. The Treasury could prioritize paying these obligations in order to avoid a default, and not pay other things that come due such as taxes it owes to itself, distributions to states, payments to contractors, among others.

Just print more money

Finally, and going back to what former Fed Chair Alan Greenspan said when the debt ceiling issue happened in the past, the US government cannot run out of money because it is the entity in charge of creating money. There is no impediment to the government spending money, since Congress has already authorized that. It’s just that the government can’t do it without falling into a practice typical of the third world, which often leads to hyperinflation.

Which means that if the x-date is breached, the most likely scenario is not a default, but a sudden increase in worries over inflation, which could push interest rates higher. Ironically, the dollar could get even stronger as a result. But, this might mean the Fed would have to step in, and resume raising rates to head off expectations of higher rates. For that reason, as the debt ceiling clock counts down, there is increasing expectation that there will be a hike at the next Fed meeting.

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