“The boy who cried Wolf” is one of the most popular Aesop’s Fables. The Fable is about a young shepherd boy who enjoyed fooling the innocent villagers by lying about a wolves’ attack on his herd. Every other day he would raise a false alarm about wolves’ attack on his herd and seek farmers’ help. Trusting him, farmers would leave their fields unattended and rush to protect his herd; only to find that the boy was lying. Over a period of time, he gradually lost farmers’ trust. One day wolves actually attacked his herd. He went to farmers to seek help; but no one trusted him; and he lost most of his sheep. The moral of the story — “when habitual liars are not believed even when they chose to tell a truth”.
The latest episode of political squabble over raising the limits within which the US government could borrow to meet its fiscal deficit, reminded of this inspiring fable. In the past two decades we have seen multiple “debt ceiling crisis” in the US. In the 15 years period from 2001 to 2016, the US Congress raised the debt ceiling 14 times. During President Obama’s tenure of 8 years, the debt ceiling was raised 11 times. Prior to that President Bush’s tenure saw 7 hikes in the debt ceiling. It is also pertinent to note that in the past 100 years, the debt ceiling has only been increased. It has never been reduced, even when the US public debt was reduced.
It is important to clarify that the Gephardt rule, as per which passing of the budget was deemed as an automatic hike in the debt ceiling to meet the approved deficit, was repealed by the Congress in 1995. Since then, appropriation in the budget and means to fund such appropriations are voted separately by the Congress. If the Congress does not vote to hike the debt ceiling in accordance with the appropriation bill, the government will run out of money to meet its interest, salary, social security and other obligations. A default on debt service would inevitably entail a rating downgrade and hike in interest rates that could impact US bond holding of all investors; besides resulting in overall higher interest rate burden on the economy.
Prior to almost every hike in the debt ceiling there had been intense politicking and aggressive posturing by both the parties. The president and treasury secretary contend that not hiking the limit may result in total collapse of the global financial system; while the majority in Congress seeks multiple assurances and concessions before agreeing to the demands.
Going with the tradition, the treasury secretary Janet Yellen has recently stated that “Waiting until the last minute to suspend or increase the debt limit can cause serious harm to business and consumer confidence, raise short-term borrowing costs for taxpayers, and negatively impact the credit rating of the United States”. She further added, “In fact, we have already seen Treasury’s borrowing costs increase substantially for securities maturing in early June.” Also, there has been usual “huge cost to American Public” and “risk of global financial instability” rhetoric being played from the Capitol Hill.
In the past, markets would usually take these warnings seriously and turn jittery. This time however, markets appear relatively much calmer; as if calling the bluff of the politicians. The collective wisdom of the market appears believing that like every previous instance, both the parties would agree to hike the debt ceiling before the 1st June deadline. Few traders seem to be taking the customary warnings being issued by rating agencies like Moody’s; investment bankers like Jamie Dimon; and Democrat leadership.
The point is whether wolves will actually come this time and eat the complacent traders? Hard to imagine, given the historical context. But would you continue to assign a zero probability to this 8-Sigma event? More on this next week.
