This article is taken from our FREE daily investment email Money Morning.
Every day, MoneyWeek’s executive editor John Stepek and guest contributors explain how current economic and political developments are affecting the markets and your wealth, and give you pointers on how you can profit.
As we go to press (ie, as I type this frantically on the commuter train into London), we don’t know who is Britain’s next prime minister.
It’s probably going to be Boris Johnson, but let’s not second-guess the result. After all, taking things for granted is one of the main reasons that politics is in its current condition.
So I just want to draw your attention to an interesting development across the Atlantic, which you probably hadn’t yet noticed.
The debt ceiling was never intended to limit spending
The US government is quite unusual in that it has an actual legislative limit on the amount of debt it can rack up. As Bloomberg points out, this was never designed as a control on government spending.
In fact, when it was first conceived, the “debt ceiling” was in fact mainly an administrative tool that made it easier for the government to borrow money.
(I’m at risk of oversimplifying here – I’m not American and I don’t know the full nuances. But the constitution decrees that US politicians have to sign off on government spending. In order to avoid having to sign off on every single new bond issue, they installed the debt ceiling instead, which allows the Treasury to issue debt when it wants as long as the ceiling isn’t reached.)
So, over the years, what has normally happened is that every time the debt ceiling is in danger of being breached, the politicians simply vote to raise it.
However, as various bright sparks realised, you can turn this into a political weapon. If your opponents are in charge of the US, but you’ve got control of the legislature, then you can stick a real spanner in the works by refusing to raise the debt ceiling when they want to spend more.
As a result, the process of raising that debt ceiling has been a constant thorn in the side of the presiding US government since about 2011. That’s when Republicans decided to use it to cause a headache for Barack Obama’s administration.
It’s easy to forget now – because ultimately, it really didn’t matter – but there was a genuine fear that summer that the US would default on its debt.
It didn’t help, of course, that sovereign default was all over the papers back then. The eurozone crisis was in the papers every day, and most of us thought it was only a matter of time before Greece got thrown out of the bloc.
So there was a lot of contagious concern about solvency about. Yet the threat to the US was a valid worry. The fear was real enough for credit rating agency S&P to downgrade US debt from AAA to AA+ (big rivals, Moody’s and Fitch, still have the US on the top credit rating).
Since then, discussions over the debt ceiling under Donald Trump have been almost equally heated. Trump most recently threatened to drive the US to default unless he got some sort of funding for his wall at the southern border of the US.
And until recently, it looked like we were heading for another clash over the debt ceiling. But not any more, it seems.
This is a profound shift that investors need to be aware of
Yesterday, US politicians – led by Steven Mnuchin on the Republican side and Nancy Pelosi for the Democrats – agreed a two-year deal to raise the debt ceiling (which now stands at $22trn, by the way).
As a result, government spending is shooting up, and at the same time, markets can relax about the remote, but not impossible, idea that the US might have ended up being unable to repay its debts.
So what happened? In effect, the Republicans agreed not to unwind Obama’s spending increases. Meanwhile, the Democrats agreed to let Trump’s spending boost for various areas to go through without question.
You can see why this has happened on a pragmatic level. Trump doesn’t need the headache ahead of the 2020 election, and, in any case, it’s always been a mostly Republican faction that has worried about debt levels anyway (it was resurrected as a big issue by the Tea Party initially).
But more importantly from an investor’s point of view is that it’s very clear from the relative ease with which this limit has been raised that both parties in the US government now believe in big spending. They can shrug off the other’s spending demands as long as they are getting their own.
Make no mistake, the US government is ramping up spending in a pretty dramatic way. The deficit (the annual overspend) is already set to hit more than 4% this year and next. Bear in mind that the European Union rules restrict deficit spending to a maximum of 3%.
(Clearly, those rules are broken all the time, but it’s worth highlighting as it gives you an idea of what the official definition of what we might call “sovereign profligacy” looks like.)
It’s another step down the road that we discussed in yesterday’s Money Morning – hedge fund boss Ray Dalio’s point about central bank money printing giving way to more direct intervention from governments.
As investors, I don’t think you can underestimate the importance of this shift. After the 2008 financial crisis, debt was the enemy. We kept racking it up, but people weren’t happy or comfortable about it.
Now, that’s changing. After years of quantitative easing by central banks, people are questioning the nature of money itself, and the idea that printing to spend might have consequences. Even the illusion of promising “austerity” or “fiscal responsibility” is no longer a vote winner.
The next batch of elections around the world will essentially boil down to competitions to promise financial benefits to competing sets of lobby groups. You could argue that this has always been the case, but now we’re losing even the pretence that it isn’t.
I think that’s profound. I think that’s something you should take into account when considering your portfolio construction. And it’s why it’ll be one of the key topics at our conference in November – don’t miss it, get your ticket at the early bird discount here.