Donna Rasile:

Hello and welcome everyone to a new episode of FinTrust Capital Advisors From the Desk Of podcast. Our podcast about markets, life, and things financial. My name is Donna Rasile, senior vice president and investment advisor here at FinTrust Capital Advisors. I am joined today with our Chief Investment Officer, Allen Gillespie. There’s been a lot in the headline news these days regarding the debt ceiling and the upcoming deadline on June 1st. Let’s take a few moments to talk about what is the debt ceiling, the potential outcome, and what this means for the markets. So, let’s dive in. Allen, can you share with our listeners today what exactly is the debt ceiling?

Allen Gillespie:

Sure, the debt ceiling is simply a limit on how much the federal government is allowed to borrow in order to pay its bills. Today, it stands at roughly $31, between $31 and $32 trillion in total. And to put it in perspective, in 2022 federal government tax revenues were just under $4.9 trillion. But we’re spending about $6.3 trillion, just under. It’s been as high as $6.8. So, without the ability to borrow, essentially, government spending would have to contract by about $1.3 trillion.

Donna Rasile:

Wow. Well, you can certainly see why that’s an issue. Can you speak to the stalemate that we’re seeing in Washington, specifically with the Treasury Secretary, Janet Yellen’s, stance?

Allen Gillespie:

So, Janet Yellen, obviously secretary of the Treasury and in that role, it’s important to recognize she is you know, part of the presidential administration, not necessarily Congress. She serves on the President’s national economic council, serves as trustee for Social Security Medicare trust funds, the depository thrift serves at the IMF International Bank for Reconstruction and Development and several other sort of international type organizations. So, Treasury Secretary obviously has to figure out how to finance things and help set tax policy and inform the president related to tax policy, economic policy. But without certain funding, right, you’re going to have to prioritize certain spending items as well. So, it would certainly change how much and what money can be spent on the debt ceiling, depending on where it’s set, to be determined.

Donna Rasile:

So, in the past we’ve had to navigate the debt ceiling issues numerous times. Can you share your thoughts about how this time may look different and is there a potential event of default?

Allen Gillespie:

Sure. Let’s take the last part of that question, maybe first. You often will hear that the US has never defaulted on its debt. I think this is a misfortune because the first question is about what constitutes a default. So, in 1979, for example, the US did miss some payments on some treasury bills for just a handful of days because of a printer error, believe it or not, sort of delayed payments going out. Now, the immediate aftermath of that was interest rates on the short end went up about 60 basis points. At the long end, people sort of fled out of longer-term government debt and obviously gold and silver and other alternatives of stock market didn’t seem to much care. It was corrected relatively quickly, but it’s often viewed as a technical default, the printer error back in the day.

You know there have been other defaults. Obviously, we went through the Bretton Woods system, you used to be able to redeem your currency for gold and that got ended. So, we certainly have changed the terms of debt repayment. During the Civil War, Greenbacks were issued, they went to immediate discounts relative to gold. And obviously at the very formation of the country, effectively we defaulted on all the Revolutionary War debt as well. Obviously, that was issued by the states, under the Articles, not under the Constitution. And Ben Franklin just kind of considered it an alternative form of taxation, right? We sold bonds and we didn’t repay it. So, it just became a tax. So, there’s a technical question of what constitutes default?

And then the second question of what is the nature of it? And then obviously inflation is just another slope form moving, in my mind, of default. Right? You’re promising people, you know, something and you’re obviously delivering something different. So, I think what’s driving a lot of this debate is we’ve seen an absolute explosion in federal spending. Now, some of that was driven by COVID. But to help people kind of baseline it, in 2019 federal expenditures were running right around just over $4 trillion a year, and here we are four or five years later, and we hit a peak of $6.8 trillion. We’re staring down $6.3 trillion. So, you’re talking about a 40 to 50% increase in federal outlays in a four- or five-year period. So, that’s probably why we have the inflation problem. I mean that’s a CAGR, compounded annual growth rate, on government spending of about 9%, which is about where the inflation rate peaked out because the private sector had to recover. Then we do all this additional spending, you know, on top of it. And that’s part of why we saw the inflationary bulge that that we’ve seen. So, I think a lot of the debate is, have we moved to this whole new permanent level of federal spending? Or should we really be dialing it back now that the private sector has recovered from COVID?

Donna Rasile:

No, that’s super helpful. And the history behind it is, you know, relevant even to today. You know the situation that we’re in. So, I’d love to chat a little bit about the macro and kind of the micro effects of what’s kind of looming out there. And so maybe if we can just kind of start on the macro level, what would be the impact if for some reason we can’t get to a resolution?

Allen Gillespie:

Well, obviously you’d have to live within your means, right? So, there’s right now outweighs or again about $1.3 to $1.4 trillion above receipts. So, the federal government is taking in right now about $4.9 trillion according to the CBO. And then it’s spending kind of in the $6.3, $6.4 trillion, so you’d have to cut spending, you know, federal spending by $1.4 trillion to stay within that limit. You know, if it’s a hard, you know, if it’s not raised at all. If it’s raised by some incremental amount, then they might have to prioritize other things that obviously the administration would like to spend money on and some of it’s just a disagreement of where money is spent and how money is spent. Some of it obviously, I think because the inflation issue, is how much are we spending, you know at all? And should we be spending? But because I think what we’re seeing is with this level of federal spending, you’re seeing government crowd out the private sector, right? Interest rates are up. That’s going to slow activity in the private sector. So, as you know, the government grows, the private sector now is shrinking. You know, there are other times where they can both grow incrementally. But I think the speed and, you know, the size of the growth obviously has put a lot of upward pressure on the inflation rate and we’re starting to see crowding out effects.

Donna Rasile:

Well, from a standpoint of investors, you know, I think there’s concerns both from a fixed income standpoint in equities. And I’d love to chat a little bit, you know, more granularly about that, particularly about Treasury bills. I think that’s probably most top of mind for investors today and what that input would look like.

Allen Gillespie:

Yeah, so on the Treasury bill side, obviously the Fed finally raised rates to kind of get in line with the inflation rate. And historically, T-bills kind of keep up with inflation because they’re just repricing quickly enough. So back to that 1979 case, Treasury bill rates went up maybe 60 basis points or so, but it was really the long end of the curve because you lose credibility, right? So, you know, people are lending money to the government for 10 years or 30 years, right? They have many more concerns about, you know, a federal system that’s not functioning well versus your ability to lend for 30 days, 90 days, 180 days. So, T-bills would probably weather it okay. I do think alternative currencies though, you know, are certainly part of that, right? I mean that’s what we saw in ‘79. That’s what you saw during the greenback issues, you know, obviously when the US went off the gold standard or Bretton Woods, metals prices, you know. Today we probably have other country currencies might come into play, you know, hard currencies would come into play, and certainly, I think cryptocurrencies might come into play in that sort of scenario. So, you know, it goes back to what’s your measuring stick? So, I think, I’ve always said they’ll pay you. I just don’t know what it’s going to buy you at the end of the day. Historically, risk assets will give you a positive return higher than a T-Bill, but you know it’s really the longer end of the government debt curves that I think would take the brunt of any. So, we have a very inverted yield curve right now. I think you would see a really sharp steepening of the yield curve if something were to happen.

Donna Rasile:

Is there, you know, a concern out there that there might not be payments in some of these T-bills as we get closer to that June date?

Allen Gillespie:

Yeah, you you’ve sort of seen that split in the market. You know one of the things we’ve seen is there’s now what are known as credit default swap curves. And so, the T-bills that come due just before, you know, we supposedly run out of money are kind of down into the high 3’s. By contrast, the ones just after that date are up a little bit from current rates. I mean, the Fed is currently right at about 5%. They’re trading at about 5.35%, equivalent of 5.40%. So, you know pricing in. So, the difference there around that window is 1.5% but from kind of current rates it’s, you know, I would say only 25 basis points, 30 basis points. But the fact that the markets even trading, you know, around window date shows, I think there are real concerns. And I would point out it was interesting back in 2008, people kind of forget this but, there were about 50 multinational product companies whose credit default swap curves traded through U.S. Treasuries, right? And so, you know, US government was later downgraded in the 2011, 2012 period. I kind of forget exactly which date but multinational corporations and, really, it’s a post-World War II phenomenon, where government debt is lower priced than the best companies. I mean, historically, mobile capital was viewed as somewhat more secure because you can move your money to where the opportunities were around the globe. Whereas unfortunately, with sovereign credit, governments do bad things. They get into wars. They lose wars. They throw out prior governments and don’t honor commitments. And so, it’s really the way cyber debt trades is the post World War II phenomenon, but it’s not consistent with the entire history of interest rates by any means.

Donna Rasile:

So bottom line, Allen, how concerned should investors be and what are your recommendations to navigate this situation?

Allen Gillespie:

On the concern side, I think there’s plenty of negotiating room. Obviously, you know, some of that is driven by politics and it’s a little dysfunctional in DC. But historically, split Congresses are forced to make agreements. So, I’m personally in the camp, they’ll probably agree to something. It would be a little less than ideal on both sides of the aisle, I think. You don’t get to these levels of spending without both sides trying to spend a lot of money. It’s just kind of who are they spending the money for and with? So, I personally think they’ll reach some sort of resolution on it and hopefully they’ll find some common ground on priorities related to that spending.

What should investors do? I mean, I think we’re in a climate where diversification is really critical as a risk control measure. I do think the inflation is going to be more persistent, but historically risk assets, companies have to pass through their costs at the end of the day. It can take time. As I mentioned around sovereign issues, there have been private companies whose debt is viewed as more secure than government debt. In fact, there’s four AAA rated companies in the world and the US government is a AA credit, just to kind of put that in perspective, even by the credit rating agencies. So, I think diversified portfolios are important. You know, I do think, as it relates to people’s cash holdings, you know, alternative cash holdings seem to be coming back in a lot of forms, just having diversified baskets. Thinking about all your risk custodial issues and, you know, money and securities, where are they kept? How are they accounted for? You know, these are things that candidly and in your and in my career, Donna, I mean I don’t want to say there was a lot more training than people that have come along in the last 15 years and stuff’s been digitized and we get a little lazy when stuff gets digitized, thinking about what’s the back-end wiring actually look like? But I think many of our investors may remember that they had physical possession of their securities and physical possession of their cash. But now if you’re relying on an institution to do that, you know there are checks and balances that you need to go through to make sure their procedures match up to standards. Right. And so, I think we’re just back into a world where thinking through these issues is important.

Donna Rasile:

I really appreciate that. Well, Allen, as always, I’ve enjoyed the opportunity to discuss timely topics to gain your insights and knowledge. And of course, your thought leadership, so thank you. Thank you all for listening today. We hope you found this podcast to be informative. It is our goal at FinTrust to provide insightful topics to add to your overall client experience. As always, if you have questions, please feel free to reach out. We’re happy to speak with you. We look forward to the next time you join us for From the Desk of podcast.

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