Economic Commentary
Daniel Laufenberg, Ph.D.

Numerous economic data series are released between the publication dates of the Laufenberg Economic Quarterly (LEQ). These commentaries are designed to provide insight on the more recent data and their implications for the economic outlook.


Debt Ceiling Politics
(July 25, 2011)

This essay responds to requests I have received for my thoughts on the debt ceiling issue. Advisors are concerned that if Congress and the President do not get together on this issue before August 2nd, bond and equity markets will respond negatively. The question is whether they should move to cash now and wait for the bond and equity markets to correct. What should they do?

I have never been very successful predicting political outcomes when politics rather than economics drive the decision. The debt ceiling issue is not economic--not yet--but purely political. However, the political decision not to raise the debt ceiling could become economic, which is the problem. In the past, the debt ceiling legislation was used by politicians to attach all kinds of "pork" because they knew that it had to pass eventually. Because of the great divide in partisan politics today, it seems that politicians are using the debt legislation this time to promote their budget policy preferences rather than just their "pork."

From an economic point of view, the debt ceiling must be raised to allow the federal government the flexibility it needs to finance itself. Some have suggested that the budget issue has nothing to do with the debt ceiling issue and therefore should not be considered jointly. There is some merit to this argument in the sense that the debt ceiling reflects transgressions and excesses of past budgets, where as the current budget debate reflects the potential additional debt outstanding in the future. However, future budgets are not totally independent of the debt ceiling in the sense that any delay with raising the debt ceiling will not save the budget but rather make the cost of servicing government debt in the future even more expensive, which in turn will complicate efforts to limit future budget deficits.

Unfortunately, the debt ceiling legislation has never done what it was hoped to do--provide politicians the legislative cover they feel they need to make tough decisions. Believe me, if the U.S. government is borrowing more than it should, the markets will let them know. With the 10-year Treasury note yield at or below 3%, the markets certainly are not yet worried about U.S. debt outstanding, a possible downgrade, or the prospect of even more debt ahead.

My best guess is that the debt ceiling will be raised at the last minute, as it is typically done. By the way, not all the new debt being issued by the federal government changes the debt ceiling requirement. For example, any federal debt held in the Social Security trust funds ($2.3 trillion in the Old-Age and Survivors Insurance Trust Fund and $0.2 trillion in the Disability Insurance Trust Fund at the end of 2010) is already counted toward the debt ceiling. These Trust Funds were established to help pay for the benefits to aging baby boomers. This has already started and will become even more apparent over the next decade. When the Treasury obligations held by the Trust Funds are redeemed for cash so that the Social Security Administration can pay benefits to retirees, the federal government essentially acquires the cash needed by issuing new debt to the public to replace the debt previously held by the Trust Funds. This simply swaps federal debt held in a government trust fund for federal debt held in the hands of the public. It adds to the unified budget deficit of the federal government, but it does not require a higher debt ceiling to get done.

For the most part, I would prefer that the debt-ceiling legislation be eliminated entirely. Politicians should be held accountable for their budget decisions without the cover of a debt ceiling. If the correct tax and spending policies are in place, the level of debt outstanding should be manageable. Politicians should never be allowed to pass a new spending bill or a tax cut because there is room under the debt ceiling for the government to borrow more.

With regard to portfolio decisions, I am not going to try to time the market around politically motivated policy decisions because they are likely to be very temporary and could change in a heartbeat. If your clients' portfolios are positioned to withstand some volatility, I would stay the course rather than try to manage around the noise. That being said, anyone who has been reluctant to take on a bit more risk over the last two years and has missed out on the rally, there may be another opportunity in the near term for them to enter the market. At the moment, I am overweight equities--I have been since March 2009--and plan to remain there until the LQ stock-allocation indicator tells me otherwise. I hope this has been somewhat helpful. period


red triGo Here for archive copy of 2010 Economic Commentary

For the current economic forecast, as well as other analysis and commentary, please visit the Stonebridge Capital Advisors website.

red triGo Here for more information about Dan Laufenberg

The views expressed here reflect the views of Daniel Laufenberg as of the date referenced. These views may change as economic fundamentals and market conditions change. This commentary is provided as a general source of information only and is not intended to provide investment advice for individual investor circumstances. Past performance does not guarantee future results.

2011 Commentary

Living in interesting times
-- September 8, 2011

A not so pleasant surprise!
-- September 2, 2011

-- August 16, 2011

Debt ceiling politics
-- July 25, 2011

Q2 growth: Another disappointment likely
-- July 14, 2011

Interpreting the ISM manufacturing index and the employment situation report for May
-- June 4, 2011

A slower start to 2011 than anticipated earlier
-- April 14, 2011

Is the dollar's status as the reserve currency at risk?
-- March 21, 2011

More trouble in the Middle East
-- February 26, 2011

Searching for the next debt crisis
-- January 13, 2011

~ ~ ~ ~ ~