Let’s start the new year with an update and a math correction. But first, please remember that this commentary is released for a Sunday publication date on the Thursday before the Friday start of the new 119th House organization for the new Congress. As I write this, I do not know the outcomes for Speaker Johnson, Rep. Boyd, the debt ceiling debate, the government funding, the Yellen warning about Treasury. My personal view is at the end; it is NOT sanguine. All opinions herein are mine alone. [Since this was written Speaker Johnson was elected by the slimmest margin in 100 years.]
On December 22nd, we published “Fishing for the Fed’s Independence” (https://kotokreport.com/fishing-for-feds-independence/). Today I want to follow up the key elements in the discussion, which involve interest rates, the debt ceiling, American policy, and more. I thank readers for their comments and responses. Some are discussed below. Let me clarify two items first.
Dan D. sent this note: “Words I never thought I would hear you say David – ‘I totally agree with President-elect Trump.’ 😊 Enjoy the Holidays!”
Also, David B. wrote: “The most unexpected line ever from David Kotok: ‘I totally agree with President-elect Trump.’ Note that I said unexpected, not incorrect.”
Kotok explanation: David B’s double negative “not incorrect” is correct (grin😊). Trump wants to get rid of the debt ceiling so he can reduce opposition to his spending, deficit, tax policy plans. That opposition is coming, in large part, from within his own party, as is now evidenced by the 34 Republicans (listed below) in the House who voted against Trump, even though he threatened them with being primaried next election and with other political pressures. (We list the 34 at the close of this piece.) That forcing of tax/spend legislation is what appears to be Trump’s motivation.
Kotok has a different motivation. I want to get rid of the debt ceiling because it is simply obstructionist, and it allows the Congress (Democrats and Republicans) to shirk their responsibility to process a federal budget. Instead of responsible governance, they use this archaic rule to create turmoil. The rule dates (1917) to the temporary financing during World War 1. Congress decided it didn’t have to approve each war loan; so, it gave the president a temporary debt ceiling. Which said (Kotok’s words), borrow what you need to fight and win the war.
Since then and over the last century, this rule has been misused by Congress again and again. In so doing they have managed to raise the interest rate and borrowing cost of the United States over and over. We demonstrated that in the December 22nd piece. Each basis point now costs America $2.8 billion a year in added interest cost. So, I want to get rid of the debt ceiling rule because it hurts the country, the economy, the citizens, the home buyer, businesses, and anyone who is financing anything.
I will leave Trump’s motivation analysis to others to determine. But, for me, the outcome of getting rid of the debt ceiling rule is the same in either case. So, I completely agree with Trump on getting rid of it.
Please note that getting rid of the debt ceiling doesn’t add a single expenditure to the budget. This was explained in detail by Morgan Stanley on December 19th in a research note written by Martin W Tobias, CFA, Ariana Salvatore, Michael D Zezas, CFA, and Matthew Hornbach and titled “FAQ: Debt Ceiling – Abolish vs. Increase.” Their research conclusions were summarized thusly:
Key takeaways
• President-elect Trump voiced support for getting rid of, rather than increasing, the debt ceiling.
• Abolishing the debt ceiling would not authorize new spending, nor come at a cost to taxpayers.
• But abolishing the debt ceiling would avoid potential significant risks in financial markets, if the x-date were crossed.
• A precise x-date is not yet possible because it’s a forecast given uncertainties around extraordinary measures, but we outline a plausible path for it to fall in 3Q25.
I’m in full agreement with the Morgan Stanley report and applaud the authors for their detailed work. For those with access, here is the link to the report.
Please note that my personal research work derives an estimate of savings if the Congress were to repeal the debt ceiling and stop the nonsense of brinkmanship. The US has never defaulted but has come close. And the reason it came close was simply because of the politics in the Congress.
The numerical calculation is important because it is large, over $50 billion a year and growing daily. And a sharp-eyed reader caught me with the decimal point in the wrong place in my earlier note. Note that 7 of us (internal proofing, editing and review) missed the error. Since my name is on the piece as the author, it is my error to claim. IMO, an author cannot shirk responsibility because of others not catching his/her error. You write it; your name is on it; you own it.
So, I must thank Michael J. who wrote: “Hi there David, Thanks for all your notes over the years; they are fantastic. One quick mathematical question: Since one basis point equals 1/10,000 (not 1/1,000), wouldn’t one basis point on $28T equal not $28 billion, but $2.8 billion? Still a lot of money, but… Would very much like to see the Congress take SOME steps at some point to reel in the deficit. In an environment where spending cuts are a political non-starter, one would think that Rule #1 would be: Don’t Cut Taxes, Whatever You Do! But alas, tax cuts seem to be at the center of Trump’s thinking. Sigh. Crisis of leadership! Regards, Michael” (last name withheld on purpose).
I thank Michael for the “catch,” as he is correct. My total estimate that the “cost” of the added interest paid by America annually because of political failure is over $50 billion or more per year is still the valid number. My error was in the formula decimal place, not in the concept.
Moving on, Maya MacGuineas, president of the nonpartisan Committee for a Responsible Federal Budget (https://www.crfb.org/), summarized the final legislation (which excluded the debt ceiling elimination) in this way:
Coming off 2023, where we saw significant savings driven by the enactment of the bipartisan Fiscal Responsibility Act, we had high hopes that 2024 would be a continuation of that trend. With interest rates and costs surging, debt projected to hit its new record in just two years, and Social Security hitting insolvency within a decade, one would think policymakers would choose to continue to reduce projected borrowing. Yet they did just the opposite. In 2024, we saw a combined $1 trillion in new ten-year debt added – the result of about $600 billion of legislation and $400 billion of executive actions. More than half of the debt from legislation – a whopping $380 billion – happened in just the final day of the 118th Congress.
(https://www.crfb.org/press-releases/lawmakers-add-380-billion-debt-final-hours-2024)
Kotok final opinion: The prospects for meaningful debt reduction are zero, IMO. The best we can hope for is a lower deficit/GDP ratio with a target under 3%. Even that now seems elusive. Kotok second final opinion: The Fed’s balance sheet is now acting as the buffer that cushions the pressure on interest rates. That pressure will grow and will worsen if Moody’s downgrades the credit rating of the United States from the current AAA. Note the S&P and Fitch have already downgraded America. Moody’s has America on the watch list with a “negative” warning. Think about all the debt of all types tied to that AAA rating. IMO, politics don’t change until there is a “TARP (Troubled Asset Relief Program) moment.”. For the debt ceiling nonsense, it hasn’t arrived yet. The pressure keeps building.
Let me get to a collection of some other readers’ comments.
Ray S. wrote:
It really was shocking to read Kotok’s latest missive describing the Fed and the political fiscal fiasco made worse by every election cycle. Debt grows worse and worse, and Kotok actually put it in print: “I agree with President-elect Trump” (his exact words), unbridled debt creation must stop. The “full faith and credit of the US Govt” is the only equity supporting our monetary system and our credit worthiness is worsening by the day. You don’t suppose those are the concerns of all who voted for Trump the second time around and a number of blue States that have jumped ship and decided that maybe Trump has something the inveterate lifer-politicians don’t have – cajónes? Could be. Maybe Kotok is having second thoughts about being opposed to anything and everything Trump touts. Perhaps upsetting the status quo was necessary, as distasteful and abhorrent as the man presents himself. We shall see. I still have many reservations about the longevity of that pair, Trump and Musk. If history is our guide, all Musk has to do or say is one word/perform one action that displeases King Donald and his ass-is-grass. Back to Tesla, Space X and plain vanilla X.
Frank M. wrote:
What the real question is, is how do we finance the obligations the government votes for? In our state, income tax is unconstitutional, so to finance everything we use a horrendous sales tax. In Seattle the rate is 10.35%. 8% is for the state and the rest is for city and county. Property tax special levies are another stab in the heart and wallet of the poor. They drive rents up, and the lessee pays, just like we will pay the price for increased tariffs. Cut the obligations? Those who live only on social security will die. The military is paid far less than minimum wage already, in the lower ranks. Our railroads and highways, if not better maintained, will fall apart. Blame it on the immigrants who come from failed states, when we can then say oh no, it wasn’t us who made this mess. No, that won’t work because our attitude in the US is I want this for me, and to hell with you. We do need to fail, perhaps, and make everyone suffer so that we can see what, by our stupidity and intransigence, we have lost.
On a happier note, Michael H. wrote:
Thanks for another wonderful year of newsletters! Merry holidays! Happy New Year! Looking forward to a few days in May with some family up in Grand Lake Stream…………..Kindest regards, Michael H., Louisville.
Former Fed official Bob wrote:
Your commentary was interesting today. I am concerned about the debt ceiling but perhaps for different reasons than you. Right now, the Fed has used its balance sheet to monetize the federal debt and is now trying to figure out what its equilibrium size should be given growth, inflation, and employment. With no debt limit and no limits on what a Trump or executive influence attacking Fed independence [might do], we could be in for a disaster economy. I view the debt ceiling as part of protecting Fed independence.
Fred wrote:
Let me take a separate path, the one Don Kohn solved – how the Fed finally got the power to do its job, after 95 years. If we need a scapegoat for the 1913 “failure” that Kohn fixed, blame “Pierpont” for dying without adequately educating “Jack” Morgan. The Fed was designed to be “bank of last resort” that would carry out Bagehot’s Dictum when needed, but Pierpont’s experience with the 1909 crisis left him skeptical because he successfully convinced TR to waste the leverage used to “save” the system on a deal that created a U.S. Steel monopoly by taking Tenn. Iron Coke and Rail. (The lawyer JP used funded the Mich Law School buildings in Ann Arbor.) As he died, I think Pierpont only trusted himself for knowing when and how to use money floated by the “Dictum.” SO, when the Fed was organized, he got Congress to forbid the Fed from paying interest to raise money for being the bank of last resort. THAT MEANT MORGAN’s BANK WOULD DECIDE WHEN THE FED GOT THE MONEY AND HOW TO USE IT (he “controlled” funds in the empire of NY correspondent banking). Had it not been for the USSC deciding (1925) that the “Dictum” imputed fraud “conclusively” when the 1929 crash occurred, I assume Morgan would have had his bank fund the Fed and take all the “good” assets to use as he wanted (in Pierpont’s “all knowing mind” he “knew” he would decide wisely). Well, Friedman, without understanding legal history determined the Fed’s inability to “buy” deposits by paying interest was fatal to its intended purpose in the 1960s, as Don Kohn studied Econ. Kohn agreed and got Congress to set a future date when the rule would change. The crisis of 2008 let him get Congress to allow it immediately. And the day it happened all hell broke loose on some NY banks that did not understand. They were forced to WAY overpay for overnight money and demanded Congress change the law. Brighter minds said “adjust your purchases of funds instead” and the next day a reasonable spread accommodated the Fed’s new IOER power. In the crisis of 2008, Bernanke walked carefully and, while 6 years to full recovery was a long time, it worked. Then, at 3pm DC time on 12/30/2019, word went out that a deadly viral pneumonia was killing people in Wuhan. Rather than get in the way of his “October surprise soybean deal with Xi”, the don decided to leave borders open. A month later he decided to leave interstate commerce to states and did not stop the viral spread of COVID, and to save his ass, he got Congress and the Fed to WAY overspend to cover the problem with cash. That overspending got the Fed and Congress where it is today, and voters have given him a second chance. That’s the history I see. You accurately report the result. Merry Christmas, Fred
Selected readings
“What Trump’s decision to wade into spending fight tells us about the next 4 years,” https://apnews.com/article/trump-budget-debt-ceiling-shutdown-musk-johnson-e0258d31a9018c7af09afc11a8634707
“Fiscal policy and the pandemic-era surge in US inflation: Lessons for the future,” https://www.piie.com/publications/working-papers/2024/fiscal-policy-and-pandemic-era-surge-us-inflation-lessons-future (hat tip to Torsten Slok for sending this our way)
“Negative interest rate swap spreads signal pressure in government debt absorption,” https://www.bis.org/publ/qtrpdf/r_qt2412y.htm
Some readers argue Trump is a lame duck the day he is sworn in; therefore, the debt deficit hand wringing is not necessary. Maybe? Here’s the history of the phrase lame duck: “Where Did the Term Lame Duck Originate?” https://www.mentalfloss.com/article/636021/lame-duck-definition-and-origin
Lastly, here’s the list of Republican Congressional Members who broke from Trump. And there are a couple of Democrats, too, who bolted from their party line to join the Republican rebellion against Trump. Lame duckism comes in many forms.
Aaron Bean (Fla.)
Andy Biggs (Ariz.)
Josh Brecheen (Okla.)
Tim Burchett (Tenn.)
Eric Burlison (Mo.)
Kat Cammack (Fla.)
Michael Cloud (Texas)
Andrew Clyde (Ga.)
Eli Crane (Ariz.)
John Curtis (Utah)
Jeff Duncan (S.C.)
Russ Fulcher (Idaho)
Bob Good (Va.)
Paul Gosar (Ariz.)
Andy Harris (Md.)
Wesley Hunt (Texas)
Doug Lamborn (Colo.)
Debbie Lesko (Ariz.)
Greg Lopez (Colo.)
Morgan Luttrell (Texas)
Nancy Mace (S.C.)
Thomas Massie (Ky.)
Richard McCormick (Ga.)
Cory Mills (Fla.)
Alexander Mooney (W.Va.)
Blake Moore (Utah)
Nathaniel Moran (Texas)
Ralph Norman (S.C.)
Andy Ogles (Tenn.)
Scott Perry (Pa.)
Bill Posey (Fla.)
Matt Rosendale (Mont.)
Chip Roy (Texas)
David Schweikert (Ariz.)
Keith Self (Texas)
Victoria Spartz (Ind.)
Thomas Tiffany (Wis.)
Beth Van Duyne (Texas)
And here are the two Democrats who voted no:
Kathy Castor, Fla. 14th
Marie Gluesenkamp Perez, Wash. 3rd
We end this Sunday note with a quote courtesy of Punchbowl News. To sign up for its daily missive go here. This was on Jan. 2nd.
Unlike McCarthy, sources close to Johnson say he isn’t willing to negotiate on the rules package for the 119th Congress, which the GOP released Wednesday. The new House rules stipulate that nine members of the majority have to band together to oust the speaker. (Here’s the section-by-section analysis of the rules, if you want to dig in.)
