Debt Debate Could Come Back to Haunt Markets

Remember all that debt ceiling drama in the United States during the summer of 2011? It appears to have disappeared, despite the US federal government regularly churning out scary deficit numbers. But I think we are likely to see this issue bubble up again before the US Presidential election.

When the painful political deal to raise the debt ceiling was struck last August, the logic was to put off the debate until at least after the 2012 elections. That August 2011 bargain in the US Congress raised the debt ceiling up to $2.4 trillion to a total of $16.7 trillion to avoid default on US government obligations.

Originally, that deal projected the new debt ceiling would be reached in early 2013, time enough for politicians to get together and work on a solution to US debt problems after the 2012 elections, which are coming this November. Only one problem: The United States has been running up the tab faster than expected, and the debt ceiling may now be close to being breached in late 2012 -- close to the November elections.

Let's just look at the numbers -- at the end of March, total US debt clocked in at $15.6 trillion. That is already $1.3 trillion more than last September's famous debt ceiling of $14.3 trillion -- and only $1.1 trillion away from the new debt ceiling. With the deficit recently averaging about $120 billion per month, that means we could add another trillion in debt in just the next 10 months.

What's most disturbing is that things don't appear to be improving rapidly. In fact, March, 2012 was a record deficit -- the federal budget deficit hit $198.16 billion, which was $10 billion more than March 2011. The US Treasury Department said last week that for the first six months of fiscal 2012, the government spent $778.99 billion more than it collected. This compares with a $829.42 billion deficit for the first half of the prior year.

Runaway Debt

Does this chart scare you? It could scare markets again, too.

The Treasury Department said this March's numbers were bad because the government moved an additional $30 billion in recurring benefit payments into the month because April 1 fell on a weekend. Outlays also increased by about $20 billion because of a re-calculation of the cost of economic stimulus programs, Treasury officials maintain.

The big problem is that even with the economic and employment pictures modestly improving, with $780 billion racked up in just six months, the United States is on track for another year of more than $1 trillion in deficit spending.

With these numbers ballooning, it seems likely that a debt ceiling debate could start surfacing prior to the election, as markets take notice and start to wonder what will be done, thus unleashing a volatile cocktail of politics more extreme than August 2011, when financial markets were roiled with the potential US debt default.

Even though most experts seeing the new $16.7 trillion debt ceiling lasting until after the election, the elevated level of deficits means it could easily be pulled into 2012, rather than 2013, making it onto the front pages of newspapers (and iPads) again. The Bipartisan Policy Center recently estimated that the deadline for breaching the ceiling may be pushed into 2012 and could come dangerously close to the election.

At the very least, there's not a large buffer zone.

The prospect of a debt-ceiling breach coming up again will embolden fiscal conservatives who threatened to block the debt ceiling extension and shut down the US government in the summer of 2011. Markets were roiled at that time until a deal was struck at the last minute to extend the debt.

Next time, it could be worse. I think there's some fairly high risk here, if only because there are a lot of politicians who would love for this issue come up just before the election so that it can create more drama and debate. Something to think about if you think the markets are giving the "all clear" signal just six months before one of the biggest US elections in years.