With each passing day, the U.S continues to face one deadline after another in the battle to revitalize its economy after the financial crisis of 2008. The U.S. government has addressed the crisis by substantially increasing spending, creating budget deficits that have caused the U.S. debt to increase 88 percent. At the same time, the U.S. Federal Reserve Bank has purchased more than $2 trillion, increasing the money supply by 223 percent. This massive stimulus of federal spending and monetary expansion is unprecedented since the Great Depression and has resulted in Gold and Silver prices increasing by 153 percent and 137 percent, respectively, since the crisis began in May 2007. The S&P 500 is down 2 percent for the same period.
No one knows the long term effects of these economic stimulus measures and there are three more major decisions coming that will further complicate the future of the economy. The following review will assist in examining each of these decisions and the potential impact on the Gold and Silver markets.
STRIKE 1: The “Sequester” Coming on March 1
The history of the sequester dates back to the debt ceiling compromise in mid-2011. In that compromise, the debt ceiling was raised and a special committee (sometimes called the “Supercommittee”) was formed to identify budget cuts by November 2011. If the Supercommittee could not identify $1.2 trillion in budget cuts over a 10 year period by this deadline, then automatic cuts, the sequester, would have gone into effect on December 31, 2012. The Supercommittee did not meet the deadline and the automatic cuts were triggered. Here is a brief overview of the history of the root cause of sequestration. As stated above, the start date on the automatic cuts (or sequester) was postponed to March 1, 2013.
As a result of the negotiations to avoid the “fiscal cliff” on December 31, 2012, Congress agreed to postpone the impact of the automatic cuts to authorized government expenditures to March 1, 2013. These automatic cuts will be implemented by a “sequester” of funds that were to be spent by several federal agencies. The “sequester” would set aside or lock up those funds so that they could not be spent. Here is a brief overview of sequestration.
The sequester, which is scheduled to go into effect on Friday, March 1, 2013, would restrict about $85 billion in federal expenditures. There are a number of discussions to address the sequester, and here is a brief review of some of the possibilities and the possible impact on Gold and Silver:
- No Action- If Congress fails to take any action, the sequester will trigger and about $85 billion will be withheld from federal spending. Gold and Silver prices may decline temporarily as traders may view this as a positive event in controlling federal spending and ultimately reducing the U.S. debt. However, such cuts in spending may also prolong the sluggish economic recovery, keeping unemployment at the current undesirable level. The U.S. Federal Reserve Bank has stated that they will keep interest rates low and continue “accommodating” programs such as the “quantitative easing,” causing traders to anticipate higher inflation and accordingly bid Gold and Silver to higher levels. Here is a brief overview of Quantitative Easing.
- Postpone the Sequester- If Congress postpones the implementation of the sequester, the budget deficits will continue and the U.S. debt will rise. This may result in higher Gold and Silver prices as traders would expect further “accommodating” policies by the U.S. Federal Reserve Bank, creating the potential for inflation.
- Modify the Sequester- IfCongress modifies how the sequester would be implemented, in effect redistributing which federal agencies would have funds restricted, the result may be similar to taking no action as federal expenditures would decline.
- Other compromises- There are many other combinations of compromise, spending, increasing tax revenues and other options, that are not easily forecast.
STRIKE 2: The Continuing Resolution Coming on March 27
The U.S. government normally runs on a 12 month budget approved by Congress expiring on September 30 of each year. If the budget is not approved by the beginning of the fiscal year on October 1, Congress can authorize expenditures under a Continuing Resolution, a process that usually extends current funding or special funding for a short period of time while the exact details of the budget can be negotiated or approved. On some occasions, the budget is not approved and there is no Continuing Resolution and the governement has to shut down because there is no approved funding. Here is a brief definition of Continuing Resolution.
On October 1, 2012, no budget was in place and Congress passed the Continuing Resolution that expires on March 27, 2013. As negotiations continue, the expiration of the Continuing Resolution is looming. Here is a brief review of some of the possibilities for the Continuing Resolution and the possible impact on Gold and Silver:
- Extend with a new Continuing Resolution- Although this result is perhaps unlikely, the political consequences of “shutting down” the government would compel the parties to agree on an extension while negotiations continue. Any delay in setting a new budget and thereby addressing the issues of the growing U.S. debt may cause Gold and Silver to rise. However, this would depend on the sentiment at the time of the extension. For example, if the debate is leaning to serious budget cuts and a lowering of the deficit (resulting in lower borrowing, thus limiting the U.S. debt expansion), it may provide weakness in Gold and Silver prices.
- Budget passed with spending cuts- If Congress can agree on a budget with spending cuts, traders may determine the government is making progress on limiting the growth of its debt. Accordingly, Gold and Silver prices could weaken on the perception that the U.S. economy would improve. However, the weakness is directly related to the significance of the spending cuts: the more significant the cuts, the more significant the weakness in Gold and Silver and in contrast, the less significant the cuts, the less significant the weakness in Gold and Silver. There may be a scenario where spending cuts are so insignificant that traders would view the entire exercise meaningless. In such a case, Gold and Silver may rise on the perception that a major opportunity to enact significant spending cuts was lost and the U.S. debt will continue at record levels, thereby contributing further to a weaker economy and rising inflation.
- Budget passed with spending cuts and revenue increases-The relative significance of the impact of any spending cuts and revenue increases would directly affect traders of Gold and Silver for the same reasons as above. However, if the spending cuts, revenue increases, or combination of both is extremely significant, traders may fear a recession and the unemployment associated with a recession. Such a scenario may lead the U.S. Federal Reserve Bank to extend or even increase monetary stimulus with quantitative easing or other monetary steps which may lead to inflationary pressure. In such a case, traders may bid Gold and Silver to higher levels.
STRIKE 3: Debt Ceiling Increase Coming May 18
In the recent increase in the U.S. debt ceiling in January 2013, Congress suspended the previous ceiling of $16.4 trillion, and gave the U.S. government the ability to borrow as much money as necessary until May 18, 2013. Here is a copy of the bill on the debt ceiling passed by Congress, HR 325.
The bill permits borrowing until May 17, at which time any amount borrowed during the suspension period will be added to the U.S. debt from before the suspension period ($16.4 trillion), and the resulting sum will be the new debt ceiling. No matter the sum, on May 18 the U.S. debt ceiling will be reached and no further debt may be incurred.
The discussion for the next debt ceiling vote following May 18 has not yet begun in earnest. However, these negotiations may be the most difficult of all issues faced since the financial crisis, as the debt ceiling is a very specific number and publicly reported. Here is a link to the page for all monthly U.S. Treasury statements. Here is a link showing the U.S. debt hitting the limit on January 31, 2013.
The last serious debate about the debt ceiling created the Supercommittee (see Strike 1 above) and the fiscal cliff as a result of inaction on the spending cuts. During that same debate in August 2011, the rating on the U.S debt was lowered by various investment committees around the world. Here is a brief review of some of the possibilities for the debate on the debt ceiling and the possible impact on Gold and Silver:
- Debt ceiling raised with associated spending cuts- In a manner similar to Strike 2 above, spending cuts may have a variety of impacts on Gold and Silver prices based primarily on the significance of the cuts.
- Debt ceiling raised with associated spending cuts and revenue increases- Results would again be similar to the variety of compromise and significance to Strike 2 above and the balance between spending cuts and revenue increases.
- Debt ceiling raised without any spending cuts or revenue increases- Without any assurance of lower deficits, an increase in the debt ceiling to accommodate increased borrowing would also increase the levels of U.S. debt without controls. Traders may view this as degrading to the U.S. economy and the U.S. dollar and accordingly bid up Gold and Silver. However, if the debt ceiling was raised on May 18 after significant progress on the sequester (Strike 1) and the Continuing Resolution or budget enactment (Strike 2), effectively reducing the U.S. debt, then Gold and Silver may be weaker.
- Debt ceiling not raised- If Congress does not raise the debt ceiling, it may be impossible for the U.S. government to adequately obtain funding, and some sort of funding curtailment would be required. In such a case, depending on the severity of the curtailment, traders may view the risk of a recession and continued unemployment at unacceptable levels too much for the U.S. Federal Reserve Bank to withhold “accommodation” and further easing of money supply, thus increasing the prospects for inflation and accordingly, rising Gold and Silver prices. However, such a case may also be deemed reasonable by traders as a beginning of the controls on the U.S. deficits and if so, Gold and Silver prices may be weaker.
CONCLUSION
Regardless of the steps Congress may take on these important issues relating to the U.S. budget, U.S. deficits and most importantly to the U.S. debt, it appears that solution to bring the record level of U.S. debt down to more historical levels will require five, perhaps 10 years or more.