Erik Weijers, 5 months ago

Debt spiral: insurance against US Government debt default reaches record price

The U.S. government reached its self-imposed debt limit or debt ceiling of $31.4 trillion (!) in January 2023. This has forced the US Treasury measures to 'pay out of pocket' to keep the government keep its obligations. The political uncertainty surrounding this debt ceiling is the reason the insurance premium against the US going bankrupt is at the highest price ever. 

If the Treasury's pockets go empty (expected in August 2023), the US government will have to shut down parts of its operation. This has happened on numerous occasions in the past. But what has never happened, is that the government couldn't pay the yield on Treasuries. The small but not zero chance that this could happen, has pushed the price of Credit Default Swaps - the insurance - on US government debt at a level never seen before (see graph below). 

What is the US debt ceiling?

The US debt ceiling is a limit on the total sum of money that the American government can borrow, which it needs to cover its expenses. It's like a credit limit on a credit card for the US government. This borrowing is necessary to cover the government's expenses when its spending exceeds the revenues it collects from taxes and other sources. Every two years or so, this 'government credit card' gets maxed out and the Congress must vote to raise the limit. Of course, this is a highly politicized issue, with both parties pushing their agenda. 

The debate over raising the debt ceiling creates uncertainty in financial markets. If it is not resolved in time, it could lead to a default on US government obligations, potentially damaging the US and global economies.

What does this have to do with Bitcoin?

The debt ceiling issue is a stark reminder of the dire financial situation of the world's leading financial power. Many analysts believe that its debt is unsustainable. In the current situation (check the 'debt clock') the interest on the debt is over 500 billion dollars per year. 

As mentioned, it is very unlikely that the US government will stop paying its debt and default. But whereas it wouldn't nominally default, it could be forced to issue ('print') more dollars and enter a period of spiraling inflation or monetary debasement. This would be a different type of default, as holders of Treasuries would lose a lot of purchasing power. They get technically paid back, but in ever more worthless dollars. 

In the words of analyst Luke Gromen the current situaion is one of: 'print or die'. He uses the term debt spiralto explain how a government with unsustainably high debt compared to its economic growth can be trapped in a downward spiral. 

How does a debt spiral work? In an attempt to pay off the huge interest on its debt, a government might cut spending or raise taxes. But both will slow economic and decrease tax revenue. This can create a vicious cycle, where slow growth leads to even higher debt levels, and higher debt levels lead to slower growth. Investors become worried and demand higher interest rates on government bonds, which further increases the debt burden. 

In the view of Greg Foss, Bitcoin is the best insurance against the event of such a failure of the global dollar reserve system. Why Bitcoin? Because in the interwoven traditional financial system, you need an institution that sits outside the system. That is Bitcoin. Unlike other financial products such as above mentioned credit default swaps, it has no counterparty risk. Read: Bitcoin as insurance.

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May 19, 2023

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