Debt Ceiling

Have you ever tried raising a ceiling? You can’t do that barring major home reconstruction. The debt ceiling is a different kind of animal, however. The idea is beautiful – to have a limit on how much debt the federal government can carry at any given time. If there is a debt ceiling, the government has to limit its spending.

Johann Wolfgang von Goethe once said: “All theory is gray, my friend. But forever green is the tree of life.” Indeed, there is one small problem here. The Congress is in charge of both its spending and the debt limit. Imagine that you could set the limit on your credit card. What would you do? Probably you would just keep on increasing it – and, guess what, this is precisely what the Uncle Sam does. Indeed, during the last 10 years, Congress increased the debt ceiling 10 times. It’s tempting to talk about the fox guarding the henhouse, isn’t it?

However, it does not mean that the debt ceiling is irrelevant. Sometimes it matters. It becomes important when the president and Congress can’t agree on fiscal policy. Then we could have the government shutdown or the debt ceiling crisis.

Debt Ceiling and Gold

Gold is considered a hedge against political and economic uncertainty. Therefore, many analysts believe that the debt ceiling crisis is positive for the gold prices by default. After all, when the debt approaches the ceiling, Treasury cannot issue new bonds. It must rely solely on taxes. The government would have to radically cut spending. Otherwise, it could have problems to make interest payments and would have to default on its bonds.

United States came closest to defaulting on its debt in 2013, when the Republican Party refused to raise the debt ceiling to fund the Obama’s planned spending (the Omnibus bill). It led to a government shutdown, but the crisis did not provide a boost for the gold prices. As the chart below shows, although the price of gold rose at the beginning of the shutdown, it declined shortly after. It rose again at the end of the shutdown, but there was no rally.

_{Chart 1: Gold prices during government shutdown in October 1-17, 2013}

Another potential link between the debt ceiling and the gold price is through the level of the public debt. The higher the limit, the higher the debt. And when the debt is rising, investors worry about its sustainability. If they lose confidence in the US economy, they sell the greenback and buy gold. The 2000s is a good example. As the chart below shows, Uncle Sam’s indebtedness ballooned in that period. That rattled the markets, spurring the safe have demand for gold.

_{Chart 2: Gold prices (right axis, yellow line, London P.M. Fix, in $) and the US public debt to GDP (left axis, red line, in %) from Q1 1971 to Q4 2018.}

In 2011, the US raised its debt ceiling, allowing trillions of dollars of additional debts. But it was too much – and the S&P downgraded the US rating from AAA to AA+ in 2011. All these factors for sure supported the bull market in gold.

However, investors should be careful in drawing conclusions here. If you take one more look at the chart above, you will notice that there were also periods in gold’s history when the metal traded without visible correlation with the US debt ceiling and the public debt. In particular, we see a rising divergence in both series in 2013, when gold entered the bear market, although the ratio of the US public debt to GDP continued to rise (although at somewhat slower pace of growth).