This Is What Happens if the US Actually Hits the Debt Ceiling

all about the trillion dollar coin. Yeah, okay, check out that episode if you want to talk about the trillion dollar coin. But today we're going to be discussing something slightly different. We are going to be talking about what exactly happens if the US actually does default, right, because if there's like just a lot of uncertainty about this question of like okay, like what happens if they don't

raise the dead ceiling? And what are the constraints, what are the various things that could happen, Like how bad would it be if we actually, like didn't pay the debt? Does the White House have ability to pay some debt but not others? Like it's pretty uncertain, Like it seems bad right, like it is lame and defaulting was bad. Russia default was bad, and Russia is like this like tiny?

You know how big was russia debt nothing? So like it is a moving feast of uncertainty, like a twirling whirlwind of chaos and uncertainty and open questions over exactly what happens. And there are all these moving parts. I think we really need to sit down and discuss them and kind of talk about it in an almost sequential way, like this is what happens if this happens, and then that happens. So we really do have the perfect guest

for this. We're going to be speaking with Joe Perks and add thoughts favorite of course, he is also global macro strategist over at Bespoke Investment Groups. So George, thank you so much for coming back on all thoughts. Hey all, thanks for having me. Let's start with the basics, since we're talking about this as a sort of primer episode on the debt ceiling and the debt limit. When we talk about limits on US debt, what do we mean exactly?

So the US is really unique in a very frustrating way in that not only do we have restraints on spending in terms of Congress authorizing and the President signing into law bills that create government spending um and then appropriations processes after that, you know, throughout the year, we also have this break on the total amount of debt

that can be issued. So Congress can at the same time instruct the government bureaucracies to go out and spend money, but at the same time say, oh, well, you can't actually issue debt to you that spending we've told you to do. And oh, by the way, you can't collect anymore in taxes because we also control that and we've

told you the amount you can collect in taxes. So it's this contradiction in terms of instructions to the executive branch and to various federal government bureaucracies from Congress and from the President, and it's it's a thing that's been around in US politics for a long time. But you know, I think the most important thing to understand about it

is that it's just it's nonsensical. It doesn't make sense for there to be this extra restraint on top of the existing safeguards against you know, in a representative democracy where people are elected and then they authorize the spending on behalf of the population. We also have this thing where there's a debt, there's a debt limit that that serves as sort of a secondary veto point on government spending.

Defenders of the debt ceiling law would say, look, kind of that's true, but it is good to have this debate every couple of years about our level of indebtedness. This can be used as a break of sorts for or constraining spending. In the Dead Ceiling fight, there really was cuts and the cuts to the growth of federal spending. You know, you're saying, like, okay, like this is like

the sort of like maddening law makes no sense. Does the dead ceiling have a history of like being used to sort of regroup and retrain our thoughts about how much we're spending. The short answer is no. And I think that the more consistent way to think about it historically is that it's used by one factionum or another in US politics against whoever happens to sort of be the party in control. So you know, this is this

is a bi partisan thing. It's used both ways. Both parties have declined to get rid of the dead ceiling on a permanent basis when they've been empowered. So I don't mean to say that this is a red versus blue you know, one side an abuser of this versus the other. But what it does is it just it creates a veto point and allows the legislative minority to extract what it wants from or some of what it

wants from the legislative majority. Now that's not necessarily the end of the w old, but there are a couple of things to think about here. First, the U S system of government is already full of veto points, right, whether it's process of buils through committees, process of builds through the House, process of builds through the Senate, judicial checks on all that, the executive branch, the high requirement

in the Senate to sign things in the law. There are some exceptions, but basically you need a supermajority in the Senate to get things signed in the law. So there's just we have a replete number of veto points, adding you know, just one more. The benefits are pretty negligible even if you agree that that. You know, controlling the debts size is a super important public policy goal. I don't happen to agree with that, but let's take that as given. Even then, there are costs associated with

this that that are very real. And the cost is the credibility of the U. S is ability to pay its debts on time in full. And you know, there are real questions about the United States Treasuries ability to settle out coupon and interest payments on debt, let alone, payments to Social Security recipients, payments to government contractors, government employeescetera, etcetera. This year because of this death ceiling being present. And again I think it's really important to emphasize debt ceiling

being present. Even though those payments, all those payments that are set to go out, all the spending, all the payments that are set to come into the treasury and formed taxes, all of that has already been approved by Congress. The debt ceiling is a secondary approval's process that has nothing to do with keeping a lid on on spending in a direct sense. So, George, you you just set out the stakes kind of perfectly there. But talk to us.

You also mentioned the treasury. Talk to us about extraordinary measures, because the U. S. Treasury has already said that it's started to take these extraordinary measures in order to meet its obligations because we have in fact already exceeded that thirty one point four trillion dollar or whatever it is borrowing limit. What are the extraordinary measures and how do they actually play out here? So there are a variety of things that go into the extraordinary measures behind the scenes.

I mean, the simplest way to think about it is changing timing of payments and sort of where there's flexibility to defer payments or to pay them, you know, without issuing debts, to wait for new payments to new tax payments to come in before sending out existing payments. That's one way to think about it. The most important thing, though, is spending down the balance that's recorded in the Treasury

General account at the Federal Reserve. So the Federal Reserve is the United States Treasuries fiscal agent, which basically means that that payments are being made via the feed. So if you're if you're the Treasury, you don't have a checking account at a private bank. You have a checking account at the Fed. There are ways in which the government is nothing like household, but in terms of access to a checking account, that is one way the government

is like a household. There is a account at the Fed again called the Treasury General Account that is essentially a cash balance, a balance available for payments that is used to settle payments owed by the Treasury to other

individuals or entities throughout the economy. And what the Treasury has been able to do since whether they're able to do it beforehand, but what if they've done as a matter of course since, is build up this this Treasure General Account in the period leading up to debt ceiling limits being reached, because that allows for flexibility over the subsequent months. Basically, if you know that you're going to be without a paycheck for a couple of months, you

save some cash away and your checking account. You're not going to buy a long term investment with it because you know you'll need it, but you'll have a little balance in your checking account, and then when your paycheck doesn't come through, you can still pay your rent for

a couple of months. You can't do it indefinitely, but you have this sort of cushion there, and that's sort of what the charge of General Account spend down is and that's the core of extraordinary measures that that allows the Treasury to continue to make all the payments it's mandated to buy law, you know, whether that's UH payments to contractors, payments to employees, payments to beneficiaries, whatever, payments

to holders of the national debt. All those can continue to go out the door as normal, in part because there's this cash balance at the t g A that's being spent down. Okay, we have these sort of like they're called extraordinary measures, but they're not like that weird. They're like little like they're more like, you know, short term cash management techniques that allow the government to make its obligations for a few extra months. Let's talk about like, okay,

when those run out, what happens? Like where where do things stand? You know? People talk, I don't know, like what is your estimate for when like the sort of real debt limit is right when we no longer have these sort of drop dead Yeah, so the X date the drop dead date? Talk about like what happens as

we get closer to that. I so, I personally don't think my estimate is any better than what we've heard from charity or from the Secretary Treasury yelling, she says June five, this sort of her best estimate, but one, It's important to understand that she described it as having

considerable uncertainty. So, for instance, if we have a really really strong tax collection season or really really weak tax collection season over the next three months, that's going to have big implications for the timing here, right, just because a huge percentage of cash flows in and out of the Treasury take lace over over tax season. So you know, there's just all sorts of uncertainties. Also, private sector of visibility is is not great into all the timing of

payments in there and their size. So I'll just make that you know, I think sometime in May June is probably the right way to think about it. Um, late mate, early June, we'll we'll hit this drop dead day where essentially there are more payments being requested from the Treasury than there is cash balance plus payments being made to the Treasury. At that point, I think it's important to stress that we don't actually know what's going to happen.

Nobody knows. There may be Treasury bureaucrats somewhere that know, um, but for all intents and purposes, they're they're not saying anything, and we we can't really be sure the I think the most popular in terms of like people saying, well, why don't you just do this option is something called prioritization, which is to make some payments and not others. So

what does that look like? For instance, if the Treasury sees that they have a payment due to the holder of a long term Treasury bond, they will make that coupon payment, but they won't necessarily make a payment to, for instance, employees of the federal government for their paycheck. How you assign a matrix of sort of like who gets paid and who doesn't get paid in that scenario is a super fraught political question that deserves a lot

of discussion. It's all hypothetical because the Treasury has said, well, we can't actually do this, We don't have the technical abilities to do this. Now, they may be bluffing when they say that one way to sort of get a better outcome around the death ceiling from the Treasury's perspective, because if you're the bureaucrats of the Treasury, what you care about is just being able to do what Congress has told you to do in terms of making payments

in and out of the Treasure General account. You don't really care about the political fight. You just want to do your job, and from that perspective, Treasury has signaled quite aggressively, Look, we cannot do prioritization. So if if we hit the X date, then we're not gonna be able to say, oh, make this payment but not that payment. Whether that's true or whether that's sort of signaling in a game that makes default very very costly for whoever lets it happen is an unclear thing, like like one.

One possible explanation is that Treasury is saying that as a way to signal to, for instance, congressional Republicans that hey, y'all can't do this or it's gonna be really really bad. If Treasury is being honest around prioritization, and again I don't have any insight, and you know, I don't have a way to say like, oh, they're not being honest, but it's definitely possible that they're. They're sort of presenting a reality that's a little bit less the case than

is other than than it really is. But assuming they're being honest, then when Treasury runs out of cash, you come to this second scenario called a general default, and that is basically saying we're not going to make any payments to anybody because everyone's on an equal footing. We can't tell payments apart, and we are just not going to make payments until the debt ceiling is lifted. That would be enormously disruptive and would obviously involve an outright

default on certain US securities. There would probably be make goals, but there would be a default. There would also be a default on everything from Social Security checks to government employe paychecks. The military wouldn't get paid, Military contractors don't get paid, any government contractor would get paid. Cash out

of the Treasury would entirely stop. So I think in terms of the first two options around like what Treasury can do in terms of making payments, like the rest pull in terms of making payments, those are the two extremes. Absolute prioritization would be they have this matrix of different priorities and they make them as they're able to, and some people don't get the payments their owned, but Treasury is able to finally tune that to like reflect what

they want to do. That's one spectrum, and the other spectrum is general fault. Nobody gets anything until the debt gets a little bit, so Obviously, general default of the US sounds very, very bad and dire. But one of the things we've seen in previous debt ceiling dramas is that as we get closer and closer to that prospect, we tend to see market participants buying US government debt as a sort of flight to safety play. So what would it mean for the actual treasury market if we

got to that general default point? What would you expect to see? Well, that is where things get really fun, because you have to sort of competing definitions of fund may vary. Fund may not apply to the non exactly. So on the one hand, any missed payment on something that is assumed as a just a general functioning bedrock principle of financial markets to never miss payments, whether it's principal or khun having a miss payment on that creates

all sorts of headaches. Not only is are are you maybe creating four sellers of people who are not allowed to hold securities that have defaulted? And we can come back to that later, but let's assume that there's some segment of the market that says we're not allowed to hold these. We we we just can't be seen holding these, So we have to sell them. On the other hand, some segment of the market would say, look, this is

a political fight. It's not a it's not a lack of ability to pay, it's a lack of willingness to pay. That's going to be temporary. So we will accept some trivial risk premium to hold these securities because at some point we trust that we're gonna be made whole. You know, we might lose a little bit, but but you know we're going to be paid something for holding these defaulted

securities in the meantime, so we'll hold onto those. So figuring out who has these securities, who has to sell them, who wants to sell them, what prices there the people who want to sell them are willing to trade at versus the other side of the of the demand for these of ALTI securities by people with a little bit looser risk tolerance. That's going to be a really there's

been a lot of volatility. As those securities work themselves out, there will be a series of bills around the debt ceiling maturity or around the debt ceiling X state that will be probably the most impacted relative to their historical volatility. Bills. Remember don't pay coop on payments, so you know, your whole payment of interest comes with the maturity of the bill, So you know, as a percentage of of your total cash flow for the instrument, bills are going to be

a lot more impacted. And they're also much less volatile historically, so you know, if you if you see for selling, you can see sort of more outside moves in those in those word are typically much safer, less volatile securities. On the other hand, you've got notes, bonds, notes and bonds which are longer term. You know, if you're thinking about a third year bond, one missed coupon payment, that that you know you probably get paid back in cash a month later. It doesn't really matter as much to

the to the total value of the security. So it's plausible that you see long term securities that miss coupon payments during that period outperform the front end of the Yolker or or or or fall. You know how their yields fall, prices go up in absolute terms because of

general risk of version. Now there's also a scenario here where and we're sort of getting far out into hypotheticals without really stressing what are our metrics for like this scenario are But there's also a scenario here where basically there isn't much change in the treasury market because the people who are willing to pay more and the people who are forced to sell or want to sell are relatively evenly matched, and everything kind of just trades out

at equilibrium levels. That's a very real possibility, is it my expectation? Probably not, But like it's it's something you have to think about. So one of the things that makes treasuries special is that they are used for collateral in the repo market. So you know, if you're loaning or borrowing a large amount of money, you will often use treasury securities as your collateral slash security in order

to do that. What would be the impact on the repo market if you had doubts over whether or not some of these bonds are in default or are in fact going to be receiving their coupon payments on schedule.

I think it's probably best to think about the repo markets an extension of the cash treasury market from that perspective, And in this scenario, I think there will be some repo market makers who are willing and able to take quote unquote defaulted treasuries as collateral and maybe apply some small haircut to them, but are willing to do it for a relatively small increase in their income from from

the activity. You know, just like there will be people who will be willing to pay, you know, slightly less than than typical for for a similar security because it's defaulted. But but not like you know half as much, you

know that kind of thing. But we don't really know the other thing, and I think this affects both the repo market and the cash market is we don't really know how well the back end settlement systems and trading systems are going to handle being able to trade something that's already past maturity right like and hopefully their QA and DEV people at banks and at funds and at other providers who are thinking about this and have have tested this. But what happens if I have to buy

on recording this February ninth? What happens if I have to buy on February ninth a bill that shows that that has a maturity data associated with it a February seven? Can the systems even accept that? Or it does it throw an error and say no, you're not allowed to

do that. I'm so glad you brought this up because this is something I've wondered about exactly, which is that with most financial instruments, when we're talking about default, you know, it's just like it's kind of an economic question, well what's there when you're going to get your recovery, etcetera. And I've always wondered whether like a US debt default, like would it almost be more like the Y two K problems. See this is a crossover episode between the

Y companies have terrible software and the U. S Treasury. No, this is exactly what I've wondered whether rather whether we're thinking about it the risks is sort of the wrong dimension, whether it's actually kind of like creates all just sort of technical things like here's the one instrument that no

one ever thinks about missing a payment on, etcetera. Right, it's like, uh, you know, I don't I don't know what the analogy would be, but I'm glad you brought this up because it seems like this could be the one thing. It's like, did they even like code the possibility that some of these instruments wouldn't get paid and what kind of like I mean it's kind of specultive, right, Like,

it's hard to answer, but I'm glad you brought this up. Yeah, I mean I think the team over Hindsight Capital would say, well, I sure hope they'd this because you know, you've known it's a possibility. Yeah, when are we gonna get this? Every single trade their way ahead of things. Um, but yeah, I mean we've known this is at least the hypothetical possibility since at least, so you would hope right that that there have been some efforts to make sure that

settlement systems can handle this sort of thing. But just because you would hope that doesn't and you can actually say like, oh, yeah, that's that's how it works. I know at some level there would be able to be

settlement of treasury securities and defaulted. I mean, you can do stuff over the phone, you can do stuff with manual settlement procedures, but there's just no way that the markets canna be able to handle super high volumes if everyone's normal trading systems are just not working correctly because of, for instance, a maturity date that's prior to a settlement date, right, Like, it's just I think there would probably be some disruptions there.

So you know that adds a liquidity dimension, and you know, liquidity being withdrawn possibly due to due to issues on the in the software, on top of the absolute risk premiums that people are willing to to bear. And you know this all applies equally to repo to you know, um, with repos. Instead of thinking like, oh, I want to buy your sell bond, it's like, oh, if I want to use this bond as collateral, can my system accept to this collateral if it's got a date that's later

than you know, same same principles basically. So yeah, I mean I don't know the answer to any of this, to be clear, Like I used to work relatively close to bank settlement systems back at my prior role, but I haven't been near a bank settlement systems in almost a decade now, So you know, I I don't know, um, and I'm not sure anyone anywhere knows with great certainty what the aggregate trading community, whether it's fast money, real money,

you know, what they can handle in this respect. But um, yeah, I don't know. So I want to talk about another you know, go back to this idea or talk about this idea of you hear payment prioritization, and of course, as you mentioned, Treasury hasn't assisted. Maybe they're bluffing that. It's technically they don't have the capability to say shut off one kind of payments easily while say like making sure that we continue to pay a debt. But setting

us technical questions of whether they can do that. What about like the political questions of who gets to decide what shuts down? Because if you're Biden and it's like, okay, like we're not gonna pay the military, and look, the Republicans are preventing the military are brave men and women from getting paid. Look, and then the Republicans might say, well, you didn't have to shut down military payment, etcetera. You could have like done something less impactful, etcetera. But who

gets to decide even a prioritization what doesn't doesn't get paid? Yeah, I think totally there are deep political questions about every facet of this whole problem. And I think it does illustrate so well how debt is a fundamentally political thing. I mean, we have our constitution because the first crack post revolution at at creating a structure for governance in the US didn't handle debt well, like, that's literally why

we have a constitution, the constitution we have today. Obviously there's more stuff in the Constitution than just management of debt, but there is a general problem here where you are taking what was the purview of Congress and elected representatives in assigning payments to various stakeholders that the Treasury faces on a on a settlement basis, and you're you're taking that away and you're handing it to Treasury with no

explicit decision to do so. If you're going to prioritize without legislation, and there will be no legislation on this, you know, then Treasury unelective bureaucrats at Treasury are just being told to make the best of it that they can and have fun figuring it out. That is not how a government's supposed to be run, right, I mean,

that's not how a democracy is supposed to function. If Congress had wanted to delegate prioritization to Treasury and said that explicitly, that would be a fine whatever, that their purview, But that's not what's going on here. It's Congress saying, well, we're not going to do anything, so just do the

best you can and throwing it back to Treasury. And when you get that outcome, I mean, that's not going to be good for anybody, regardless of who the winners and losers Treasury picks are, if they even have the ability to make those picks. It's it's it's it's a pretty deep irony that that a representative democratic system is doing this to itself. And again, I just I want to emphasize that this is Congress doing it to itself. This is not this is this is not inherent thing

around that national debt management. This is a series of bad decisions that have been made by elected representatives over the past thirty or forty years that have gotten us to this point. And it's entirely a self inflicted situation. I think this is such an important point to make, this idea that debt is ultimately a social construct and inherently political in many ways. You know, it tells a story of who owes who what and why, and so it's immediately caught up in you know, the potential for

different narratives. You mentioned how self defeating a lot of this tends to be in the US, and it does seem to put it mildly that defaulting on US debt

would be bad. So what would happen if, you know, the executive branch just just decided to ignore Congress on this, Like what if people just go off and you know, the president goes off and does his own So earlier we were talking about, I mentioned how fun it would be if we had a general default and what that would mean for the treasure market as for the treasury market functioning fund, same thing for constitutional fund in this

instance that you just described. Um So, just as a bit of background, if you read section four the fourteenth Amendment, one of the key reconstruction amendments after the Civil War, there's a clause that says the validity of the public dat of the United States, authorized by law, including debts incurred for payment of pensions and bounties for services and

suppressing insurrection and rebellion, shall not be questioned. So this is just basically saying, like there's a general constitutional principle that if the United States government owes someone something, you can't get in the way of that right like that, that's the plain text reading of that. How far do those powers go? It's an it's an interesting question. No,

one's ever really litigated it. This this this clause section four was mentioned in a in litigation around a new Deal case, but it wasn't it wasn't really directly established to be read in a maximalist or minimalist way. Other parts of the fourteenth Amendment have been litigated to the end of time. I mean, it is one of the most litigated parts of the entire Constitution that the Spring

Court heres cases on. But this particular section has very little litigation associated with it, so we don't really know what courts would do. But if you read that that that text, just as you know, sort of a plain text, then it seems to create a constitutional obligation to pay the public debt of the United States. And it's one thing to say, well, you know, we can't pay the

public debt because we've run out of dollars. But we know you and I, Joe and Tracy and hopefully odd lots of listeners at this point know that to treasury creates dollars. In the Federal Reserve creates dollars, and there's no there's no lack of those dollars there there you can't run out of them. So that's not that's not

a restraint. What what then, is preventing the federal government, or specifically the executive branch and the Treasury, from going out and doing what the Constitution tells it to do by preventing people from questioning the debt and just saying, restraints on issuance of debt to make good on payments owed by the United States to third parties are I'm constitutional. The dead ceiling is I'm constitutional, and we're going to keep issuing debt until to to make payments until someone

tells us to stop. That path is one that is hard to see from a political a political group that has been as risk averse as the Biden administration has been. But I do think you can make a very good case that in an emergency, a situation where there's a general default, where you know markets are crashing, where you know there's there's massive economic disruption, that this is a good choice to be made, that that that the debt ceiling is totally self defeating. It's a it's a it

shouldn't exists in the first place. And by the way, there's a constitutional reading right here. Now. I'm not a constitutional scholar. I'm not a constitutional lawyer. I'm none of those things. Um, like jay Z said, you know, I passed the bar, but I know a little bit. I know enough to know that this could hypothetically work. But that's about it. So I don't think I would predict that the bid administration should or could go out and

do this. But it is interesting to think about how these powers appear to be given to them by the Constitution, and that there could be a Supreme Court case settled based on whether the US has just issued bonds that are illegal under the Constitution. You know. Again fun, So, okay, we're not going to have like a coin conversation. But this does get to the other possibility, which is these

technical workarounds that people believe exists in the law. So one possibility one of these workarounds could be invoked the fourteenth Amendment, And it seems pretty clear the history on that does not seem to be particularly ambiguous about why it's there, And it's kind of you know, I'm reading on Congress dot gov inspired by the desire to put beyond question the obligations for the government issued during the Civil War, and so like, I don't know, like it

doesn't seem particularly ambiguous, but setting aside the fourteenth, talk to us about some of these other ideas in the law to avoid a default. I think the easiest one to understand and easy by the you know, if you know a little bit of bond math, The easiest one to understand is this idea of issuing very high coupon bonds. So when when we issue a bond, typically what happens

is there's a bullet bond. Is the is the standard term for what people think of, as you know, for instance, a treasury bond, where you get a series of payments over time that are called coupons, that are regular small payments, and then you get a big payment at the end, which is called the principle. Right principle is you know, typically you you pay you you quote the price of a bond as the percentage of the principal payment that

you will receive at the end. So for instance of bondus trading at that means you pay now and then you get the series of coupon payments associated with that bond and the principal payment at the end, which is a hundred. When Treasury auctions securities they are sensitive to they basically want to set the price of those securities just below one when they're first issued. Um, they don't

want to issue bonds at a premium. And they also have a serious other constraints, like, for instance, the minimum increment of coupon. So what they'll do is they'll issue bonds with a coupon that sets the um the principal payment um or sorry, sets the auction price just below

a hundred when they when they issue. So, for instance, they're not going to go out and issue a fifteen coupon coupon bond when the prevailing yield on treasure securities is like five percent, right like like like, they're never going to do that. But that's just like an internal norm that's not like written in law anywhere. They don't

have a legal obligation to do it that way. If they wanted to, they could go out and issue a bond that matures with a principal value of a hundred and pays coupon payments of a hundred, you know, hundred per year for the next thirty years. Say so let's say, for instance, they did this, they said, well, we're gonna issue what's called a super high coupon bond, and again this is nonsense territory from a from a pure finance perspective.

But let's say they go out and and that bond that matures thirty years from now at a phase five, it will pay a hundred and coupons every year as opposed to the you know, four percent coupon on the

most recently issue third or bond something like that. So if you do the bond math on that, if you if you discount all those cash flows back to present value at the current prevailing interest rate, what you've got is an eighteen hundred dollar You receive eighteen hundred dollars today for the bond maturing at a hundred in the future. And the reason you get that is because it's got that long string of payments associated with it, whether the

same size as the as the principal payment. You've basically issued a zero coupon strip, all in one instrument for the next thirty years. And you've done that, you're the impact to the debt ceiling is a hundred, but you now have another seventeen hundred in your in your pocket because of those coupon payments. Those coupon payments aren't covered by the debt sailing their coupon payments not principal payments.

Right that when when Treasury counts debt, they're not counting the coup the interest costs, they're counting the principal value. So hundred dollars is I mean, like like it's a technicality where you can say, well, the coupon isn't principal, but it's still cash in my pocket now delivered at a later date that doesn't count against the dead ceiling. So you know, that would be another technical workaround they could use. Again, this one is on much less dicey

legal footing. There are lots of reasons why Treasury maybe want to say we don't want to do this, Um, we don't have any interest in this, we're not able to do this whatever. There There could be lots of reasons for that, but but legally it's it's not quite as dicey as saying to Congress in the Supreme Court, well, we're just going to keep issuing Debton. You know, take

your best shot at stopping us. I'm trying to think what would be a harder sell to the public is that, you know, issuing a high coupon bond that like gets you immediate proceeds that are a lot more than the actual issue once amount, or is it a large novelty coin. Well, I mean, so I was gonna you know, the novelty coin. I'm sure you know, well, we know the headlines are

gonna be on that. But you know, at the same time, I'm I'm imagining Biden is borrowing at a hundred percent interest rates from China to like the payday loan to like you know, like the the The headlines could go in either direction, for sure, Yeah, I mean, but then you have to explain like like what how it's even possible to borrow a hundred percent interest rates or or like what is even happening there? I mean, I do think both the coin for for all it's downsides tracing.

I know how much you love the coin, but you know the benefit of both the high coupon bond plan and the coin plan is that they're weird incantations, you know, run by technocrats. They're not They're not like a tangible thing where it's like the U. S Constitution and like this sort of feeling that the world is going straight. It's like, oh, well they said the right words and everything is fixed now. So who cares is is how

people tend to think about this stuff. I think. Whereas when you're talking about the Supreme Court and the Constitution and Article um section four of the fourteenth Amendment and the history and that, people get very arpen arms all the Constitution, you know whatever. Whereas if it's just like, oh, well we just said the right words magically to the bond market and now everything's fine, I think you get a very different you know, feeling from that politically. But

that's speculation on that part. This is something that's important, which is that okay, let's say the administration to say, you know what, the fourteenth Amendment says, the dead sailing is invalid. We're just going to ignore it and continue fiscal operations as normal. And then, as you pointed out, there might be some ambiguity about whether the bonds issued after that moment are legal, and maybe there would be get to the Supreme Court. We don't really know what

they were going to say. But to some extent, this even applies to any other solution as well, including the high coupon bonds, including the coin, which is that like someone could sue over the coin, Like no one's gonna stop it. And if like five out of the nine Supreme Court justices says you can't issue a hundred year bonds, like that's clearly in violation to the spirit of the

dead Sailing law. You know, you're still issuing debt at a time when we're not supposed to issue any more debt Like the uncertain the exist in almost any of these scenarios for sure. And you know we set it before, and I'll say it again, this is all a political question, a social question, right like that, Like political power means telling people to do something that they don't want to do.

That is what political power is, right, And whether it's the Biden administration forcing issuance of new debt, whether it's the Supreme Court stepping into either validate that or or

or invalidate that. You know, that's the fourteenth a medi scenario, or whether it's the Biden administrations saying, Okay, we're not going to make any payments regardless of who doesn't get paid, or it's prioritization where some people get paid, for instance, bond holders maybe get paid, but you know, retirees don't

like whatever approach you take to this. At some point someone is being told you don't get what you want because you can't stop me, you know, under our system, right like like you physically can't stop me, or you know, enough of other political bodies have sided with me so that you can't get done what's what you want to

get done? And you know this is a like at the end of the day, the dead ceiling has lots of interesting financial and economic and analytical things to explore, but it's always going to come back to being a political problem. Was created by politicians. It's it's being exacerbated by politicians, and it will be solved through political means and nothing else. And you know, I just I'll always

come back to that. I I really in that. From that perspective, I cannot emphasize enough that that Congress has created this problem for itself, and if there was justice, then Congress would lose power in some sense over this, whether it's the death ceiling is invalidated by the Supreme Quarter or by the by administration or whatever, or you know,

some other solution. Unfortunately, like the world doesn't work based on karmic justice, So I don't think we can hope that oh well, the you know, Congress gets its come up in but maybe they will. I mean, we'll see. I mean, it's gonna be an interesting few months here,

to say the least. So the overarching theme of this conversation is just mass uncertainty, lots of hypothetical shooting out in every different direction, and no one really knows what's going to happen when we finally hit that X date, the drop dead date. But there is something sort of more immediate, a potential more immediate impact. And I think we touched on this when we were talking about t g A balances, this idea of you know, the Treasury is checking account at the Fed. It does have an

impact on liquidity. So what's going on with the t g A. You know, if there's more money in there, if there's less money in there, it can mean different levels of liquidity for the broader economic system, for companies that might be due payments from the government. Talk to us a little bit about the immediate impact of all this discussion over the debt ceiling on market liquidity and

money harry policy as well. Yeah, so this is kind of a perverse thing about how the mechanics of of the t g A being inflated with that sort of cushion we discussed earlier. It's perverse how this works, because when the Treasury is building up that cushion, they are

withdrawing aggurate liquidity from the private sector. Treasury is withdrawing liquidity from the private sector because that increase in t g A balances is being funded by some combination of higher debt and you know, higher tax as relative depending it's debt, right, the Treasury is issuing more bills and more notes and bonds than they technically need for the specific period in time. That means cash balances are being dragged out of the private sector and to the Treasury's

cash balance. At the FED, that's a federal reserve liability, just like a FED fund is, but in the but the liability that the FED holds in the t g A, the only asset, the only person who can hold that as an asset is Treasury, whereas Federal reserve FED funds are an asset that can be held by the banking sector and used to match against deposits that are an

asset of the rest of the private sector. So basically it's like reverse quite right, when this TJ is being built up, it's it's it's pulling liquidity out of the private sector and storing it in the t g A. Then the t as the t J is released, it does the opposite, right, so it unleashes private sector liquidity because that liability of the Federal of the Federal Reserve to the Treasury is being spent down. The payments are wounding up as assets of the rest of the private

sector or the rest of the world. Basically, everybody but the federal government funded by Federal Reserve FED funds liabilities of the of the FED. So it's basically a countercyclical thing, right Like it's it's as as times are good and we're you know, go along and t g gets built up and then we've got worried about that ceiling. But at the same time, a bunch of liquidity as being unleashed. Now, the sizes here are not necessarily huge. It sort of

depends on the specific instance. But the size of the t g A has gotten pretty big relative to the rest of the Fed's balance sheet as a matter of course. So prior to the global financial crisis two thousand seven, two eight kind of range, the TJA was less than one percent of the FEDS balance sheet. Basically payments in payments out almost precisely matched each other day to day. From two eight fifteen, it built up a little bit because just the scope of federal government spending went up.

There was a lot more issuance of debt with post crisis deficits that were that slowly sort of declined from the peaks in two thousand nine. But then when we get to and treasure says, okay, well we want to start building up this this cash balance from average six percent of the Fed's balance sheet UM so it was below one percent before the goal financial crisis immediately after is about two after that. After six since q it's

been eleven percent of the FEDS balance sheet. That's a huge percentage of the FEDS balance sheet, and it swings around quite a lot, unlike, for instance, the q AST

purchase portfolio. So basically you've got this complicating factor that has nothing to do with the FEDS monetary policy UM setting that the FEDS, the FED is not changing policy based on treasury cash management, and yet it's got this this sort of impact on aggregate private sector liquidity, both positive and negative depending on what's going on with the t g A UH, do you have to account for so you know, as we see the t g A

spend down over the next few months, it's already underway. Um, that will have an impact on aggregate private sector liquidity. That will be kind of sort of counterintuitive. I guess you could say. Right now, there's about five hundred and sixty billion in the Treasure General account. That's down from a peak of almost a trillion in May of last year.

The recent peak, it's it's it's it's sort of trended lower over the past seven months or so, and that will continue to trend lower as we go from five sixty down to zero presumably or near zero at the X date. All right, I want to ask one more markets related question, and I think there's this fantasy that people have, which is that the stock market becomes the sort of forcing mechanism. The example that everyone would site

is the tarp out. It failed in two thousand and eight, and the stock market crashed some more, and then they passed it a couple of days later. It doesn't seem like that dynamic really holds with the dead ceiling, because even though there's this potential for catastrophe, on certainty, the view amongst stocks investors seems to be they always get it done in the end. Why would I sell my stock, etcetera.

Like can you talk a little bit about, like, as we get closer, is there any sort of like history or like the sort of interplay between market volatility and pressure to just like all right, let's get it past. There is no doubt that there is a feedback loop between asset markets and how politicians think in this country.

I mean, using a more recent example from then the top vote, which I think is a good, good one, you could look to what happened in the spring of right, we saw a degree of fiscal stimulus and a degree of support for households that completely unprecedented in American history and completely like if you had dreamed up the scenario where that happens, even if you had you know, no one about COVID coming, and you had said, okay, well, then you're going to see this public sector response to that,

I don't think anyone would have believed you. They just said, no, there's no way that the Republican Congress will will do that. There's no way that there are no Republicans and Congress will okay that, There's no way that I'll get through filibusters and all that, and it absolutely did, and it did so immediately because asset markets were in free fault

right there. There is a lot more feedback to political economy in this country and to political out comes in this country from the stock market then from the unplaying right. That is just how things work. I'm not defending that,

it's just the reality. So I do think that if we if we see stock markets start to false you know, measurably, you know, like like big volatility, big downside in the months or weeks leading up to the sort of X state as it sort of becomes more clear, then you will definitely seem a lot of pressure on politicians to to just just raise the dang thing, you know, have

your fights about something else. Whether that comes from people within the respective ideological goals of each party, whether that comes from the public as a whole, it's unclear, but

either way there will be significant pressure. If, however, stock markets say, well, you know, like they'll figure it out and event you know, maybe there there'll be a default, but like they'll pay those back eventually, and people be commented and like area with plenty of people that are willing to pick up an extra twenty five basis points in a Treasury bill to hold it for a few months while they figure out this, this this out and it'll be fine, and so we can just sort of

look past that. If if that happens, that's a recipe for a much more protracted fight and a much longer time past the X date with you know, uncertainty going on. Now.

My view would be that if you if you get to the X date, even if you have prioritization, barring using one of the technical workarounds we discussed, so either the coin or using high coupon bonds or um just saying well, this violates the fourteenth Amendment, so we're going to ignore the death ceiling if you if you you know, don't have those and you have either prioritization, which Treasury said isn't possible but could be possible and you're working

through prioritization, or if you're just doing a general default, We're we're not paying any payments until the dead ceilings race, because that's that's what the law tells us to do.

If if I'm the Treasury, okay, either way in either a prior to a severe prioritization scenario or a general default, you're going to have large economic impacts from that, right, Like like that, the volume of outgoing payments that are not going to show up in the bank accounts of people that want to spend them, whether those are businesses whether their individuals, is going to be really big. Social

Security is a really good example. Like if you start paying Social Security, the entire economy grants to a halt about a month. There's just not it's it's just such a huge cash flow for such a large percentagers of population that you can't So eventually there will be a feedback to asset markets. This will not last forever where it's just kind of the new normal that the US is permanently you know, has the destiny in place, and

you know, only making some outgoing payments. Eventually the economy starts to collapse, the stock market starts to collapse, and you you know, you see and another interesting thing, just to work it back to the Fed. An interesting thing to think about it is if the economy is collapsing because all these payments aren't going out and the stock market is in free fault us, the FED step in to say, okay, well we're going to cut rates now.

Because the economies and free fall because of what's going on with the dead sailing or do they say not our problem? I don't know. I don't have a good answer for that. I don't I don't think a good answer exists, but it's something interesting to think about. It feels like this is one of those topics where there just aren't a lot of good answers. But George did a good job. Yeah, you did a great job. There's a lot of uncertainty and hypotheticals as we've been talking about.

It's not an easy thing to sort of lay out all the different options and what might happen depending on what's pursued. But George, it was great having you on. You did a great job. Thank you so much. Yeah, thanks for having me on. I mean I can stick around for another three hours and we can get all the different hypotheticals if you want. All right, now our to the coin conversation. Okay, I'm thanks man, let's go. Thanks for having me on, George. Thanks George. Joe. There's

a lot to unpack from that conversation. I agree, But George did like a great job, Like you know, there is a lot of uncertainty. I guess because it's something that had been lodged in my mind. But like, I'm glad he brought up that question of like the software element of defaulted debt, because it's just something like I want like people like you know, like we don't talk about debt in those terms. It seems totally like a Y two K thing, as you mentioned, where people just

would not expect US treasuries to default. And anyway, why would you prepare for such a scenario, because if that were to happen, then it would be the collapse of the financial system as we know it. But yet here we are, you know, after two thousand eleven, after having a very similar conversation. The other thing that's stuck out in my mind was George's point about, you know, ultimately this is a political process and it plays out in debt.

But the reason it plays out in the debt market is because debt is inherently, I think, so tied up with questions of morality and justice, and it's so easy to build a political narrative on top of something that is ultimately about who owes what to who and why? Absolutely, And you know, I think that's why it's really notable that this was written into the constitution, and we run into the constitution after the Civil War. And what we

did have that coin conversation was with Roman Grande. He talked about this as well, which is that like this fear that in the pursuit of the Civil War that southern representative representatives from the formerly confederate state would try to induce a default because it's like, oh, we don't want to pay the debts of the northern government that fought a war against does and so they did, like they this is like, you know, it gets to like

deep constitutional questions and it continues to play out over and over again in different forms, the political weaponization of debt. It seems to be happening more often because I think people have realized that it is an effective pressure point. As George laid out well on that happy note. Shall we leave it there, Let's leave it there. Okay. This has been another episode of the Odd Thoughts podcast. I'm Tracy Alloway. You can follow me on Twitter at Tracy

Alloway and I'm Joe Why Wasn't Though. You can follow me on Twitter at the Stalwart. George doesn't really tweet anymore, but maybe he'll come back one day, so I'll plug it anyway. His handle is at Perks. Follow our producer Carmen Rodriguez at Carmen Armand and Dash Bennett at dashbot. And check out all of our podcasts at Bloomberg. Under the handle at podcasts and some more odd Lots content. Go to Bloomberg dot com slash odd Lots when we

push the transcripts. We have a blog, a weekly newsletter that goes out every Friday. Go there, sign up. Thanks for listening. See to