The US Federal Government has spent more than it earns virtually from its inception. The first recorded deficit budget that had to be financed by a loan was that of January 1791.
Since then, government spending has consistently been more than government income, although there were relatively short periods when income exceeded expenditure.
When the government spends more than it earns, it has to borrow the difference. In the US, this is done through the issue of Treasury Bills.
Since the 1960s, the percentage of US Treasury Bills held by foreign countries has been steadily increasing. At the moment the biggest buyers of US Treasury Bills are China, Japan, and the United Kingdom.
US Debt Ceiling
Article 1, Section 8 of the US Constitution has put Congress in charge of managing public debt.Initially Congress had to authorise every issue of Treasury bills separately, but in 1917 it was decided to simply implement a debt ceiling. As long as Government debt does not exceed this limit, approval from Congress is not necessary.
US Government Debt Crisis
Over the years US spending has steadily pushed up the level of US Government debt, often as the result of wars such as WWI, WW2 and lately the invasions of Iraq and Afghanistan,.When this debt level reaches a point where it approaches the debt ceiling, Congress has to authorise an increase in the ceiling.
President Obama is now, July 2011, asking for a $2 trillion increase in this ceiling, which will only be sufficient to ensure the US Government can keep on functioning until the end of 2012.
When the politicians controlling the US Congress cannot come to a decision about increasing the debt ceiling, it raises the risk of the US Government being unable to meet its obligations.
In this case, welfare payments or other Government programmes might have to be stopped.
Short Term Effects on Forex and Stock Market Indices
When the US Government ends up in a position where its lending approaches the debt ceiling, it can only roll over existing debt and cannot issue new Treasury bills.What happens next is usually that the demand for the existing bills exceeds supply, causing rates on them to drop. This can clearly be seen from the chart below, where the Treasury bill rate is currently much lower than three months ago.
As government expenditure comes closer to the debt ceiling, and fears of an impasse start to grow more intense, the stock market indices are often negatively affected, unless of course there are other mitigating factors.
Such a situation also generally puts downward pressure on the US Dollar, although again this could be mitigated by other factors.
Once the politicians agree on increasing the debt ceiling, the stock markets and US Dollar forex spread betting markets normally react favourably, even though this might be short-lived. Rates on Treasury bills also usually start increasing again.
Spread Betting on the Markets During US Debt Ceiling Talks
Some traders look to trade on the US markets during such talks in an attempt to gain from the potential swings.They might do this by going long on the US Dollar, or a stock market index such as the S&P 500, after a suitable downward move but before an agreement on the debt ceiling is reached.
There are, however, risks involved with such a strategy as it relies on the assumption that an agreement will be reached before the deadline. A prolonged stalemate, or failure to reach an agreement, could have unforeseen consequences that might send the spread betting markets into a downward spiral from which they might only emerge after an extended period of time.
Good luck and happy trading
Shai Heffetz, InterTrader
(Original article written 21 July 2011).
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