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Treasury officials are working on contingency plans should Congress fail to raise the debt ceiling by the August 2 deadline. The plans would lay out how the government should proceed to operate in such an event. However, any plan the US Treasury comes up with is only meant as a suggestion to the administration, and furthermore, would not be able to prevent U.S. interest rates from increasing, the dollar from devaluing, nor global financial markets (NYSE:XLF) from taking a hit.
Don’t Miss: 9 Investments to Hedge Against a US Debt Default.
One possible option President Obama may take under consideration is an assets sale, which could raise money to help cover the government’s obligations. However, such a step would signal to the world the vulnerability of the government, not to mention it would be forced to accept undervalued prices and the money raised would be unlikely to buy much time.
Obama could invoke the Fourteenth Amendment, which some say has a provision allowing the president to act in any way necessary to ensure that the United States’ public debt “shall not be questioned.” Some legal scholars contend that the clause gives the president the right to raise the debt limit on his own, bypassing Congress. However, in so doing, Obama would be greatly extending his executive powers and setting a new precedent, which would have a host of potential ramifications. Furthermore, Obama’s administration officials do not believe that the fourteenth amendment grants the president that power, and elsewhere the Constitution grants Congress the sole authority over borrowing money.
Probably the most likely scenario to play out as the government runs out of money to pay for its obligations is a prioritization of payments. It is most important that the government be able to keep paying interest on its debts, which means payments to recipients of government benefits, government employees, government-funded programs and projects would be delayed indefinitely.
In August, the Treasury will collect $172 billion in revenue, and will be limited in its spending to that amount. However, as of now, the government has scheduled $306 billion in payments for next month, meaning it will have to find a way to cut its budget by 55%. The 45% of its obligations the government is able to pay will likely be those that are in the interest of protecting its credit rating and keeping treasury yields from skyrocketing. CHART OF THE DAY: Watch the US Debt Set a 60 Year Record.
Pursuing another possible contingency, Geithner met with Federal Reserve Chairman Ben Bernanke last Friday. While officials say the Fed could not act as the Treasury’s broker and borrower money on the Treasury’s behalf, it could help with operational issues since it clears all government-issued checks. Philadelphia Fed President Charles Plosser says issues that could be looked at would include, “How the Fed is going to go about clearing government checks? Which ones are going to be good? Which ones are not going to be good?” The Fed could also play a role in monitoring the market’s reaction in the event of a default or credit downgrade
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