The Imperial City’s Fiscal Waterloo – Daily Reckoning

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Its all over now except the shouting about Obamacare repeal and replace, but thats not the half of it.

The stand by Senators Lee and Moran was much bigger than putting the latest iteration of McConnell-Care out of its misery. The move rang the bell loud and clear that the Imperial City has become fiscally ungovernable.

That means there is a chamber of horrors coming. With it, an endless political and fiscal crisis that will dominate Washington for years to come. Its cause is deep and structural.

The founders, in fact, were small government de-centralists and non-interventionists. Thats why they agreed to Madisons contraption of redundant checks and balances.

Aside from ruthlessly ambitious Alexander Hamilton, the founders wanted a national government that was hobbled by levels of hurdles and vetoes. They wanted a government that could act sparingly and only after thorough deliberation and consensus building.

And that made sense. After all, most believed that the 10th amendment was the cornerstone of the Constitution. Neither Washington or Jefferson envisioned the political and fiscal burdens of running an empire.

It is our true policy to steer clear of permanent alliance with any portion of the foreign world. That was George Washingtons Farewell Address to us.

The inaugural pledge of Thomas Jefferson was no less clear in stating, Peace, commerce, and honest friendship with all nations-entangling alliances with none.

So when Woodrow Wilson embarked the nation on the route of Empire in April 1917 and FDR launched the domestic interventionism of the New Deal in March 1933, the die was cast. It was only a matter of time before the disconnect between a robust Big Government and the structural infirmities of Madisons republican contraption resulted in a deadly impasse.

The Fed has now backed itself into a corner and is out of dry powder. Even its Keynesian managers are determined to normalize and shrink a hideously bloated balance sheet. The current account has no basis in sustainable or sound finance.

The time of fiscal reckoning has come. With the financial sedative of monetization on hold, bond vigilantes will soon awaken from their 30 year slumber.

First up is the imminent debt ceiling crisis. Republicans will never reach agreement on a bill to raise the debt ceiling by at least the $2 trillion that would be needed to get through November 2018. Thats because the Freedom Caucus conservatives would never agree to a clean debt ceiling bill. By agreeing to such a measure, they would betray the fundamental reason they went to Washington.

The Washington Post reported that sentiment exactly this morning in comments from Freedom Caucus Chairman Mark Meadows:

Meadows said that he recently attended a meeting of eight of the most conservative Senate and House lawmakers about how to handle the debt ceiling and that not once did they consider the idea of backing Mnuchins proposal for a clean debt-ceiling increase.

The end game is quite clear. After several false starts, the Trump White House will be forced to turn to Democrats for votes to raise the debt ceiling but it will come at a price.

Not only would Trump be forced to bailout Obamacare with subsidies to insurance companies to keep rates out of double digits and coverage on state exchanges from collapsing, but it would also mean setting aside his vaguely outlined domestic agenda.

That would include dropping the sweeping domestic spending cuts contained in the Administrations budget and settling for a modest tax plan constrained by revenue neutrality.

Even if Trump were to agree to a quid pro quo with Democrats to get votes for a debt ceiling increase, it would soon be surpassed by a far bigger consequence. It would be the complete implosion of any functioning Republican majorities on Capitol Hill.

Thats because a White House deal with the Dems on the debt ceiling would amount to giving the GOP rank and file release from party discipline ragged as it already is on fiscal matters going forward. White House complicity in Obamacares rescue would be considered an unforgivable betrayal.

The Donald has almost no real friends in the Imperial City among the ranks of the seasoned political pros who run the Congressional GOP. After a debt-ceiling-for-Obamacare-bailout deal with the Dems, he would have no friends at all. The President would then be completely beholden to political enemies.

The nave notions about bipartisanship and working with Democrats held by the White House inner circle of economic advisors will then come into play. As far as we can tell, both Secretary Mnuchin and chief economic advisor Gary Cohn (and son-in-law Jared Kushner) are lifelong Democrats. They are individuals who have no fiscal policy principles whatsoever except doing whatever is necessary to keep the stock market rising.

They would likely lead the Donald into a fatal debt deal with the Dems based on the doctrine that the credit of the U.S. must be preserved at all hazards. By doing so, the Wall Street/Washington establishments fifth column in the White House will bring about the final defenestration of what is left of Trumps presidency.

The astute leader of the Freedom Caucus made the devastating political cost of such a maneuver crystal clear. In recent commentary on the impending crisis, referring to Mnuchins campaign for a clean debt ceiling bill, he explained there is no such thing as 50/50 GOP/Dem coalition to pass a debt ceiling bill.

The minute the White House starts making concessions, the GOP bench will jump off the ship in droves. It will then become an overwhelmingly Democrat vote show:

Hes certainly in the minority in the administration, said Rep. Mark Meadows (R-N.C.), chairman of the House Freedom Caucus. The problem is, yes, you could get a clean debt-ceiling, but it would be 180 Democrats in the House with 40 or 50 Republicans, and thats not a good way to start.

Before Trump is forced into a surrender, there will be the same vote count maneuvering in GOP caucuses of both Houses. Similar to what preceded the GOP collapse of their seven-year crusade against Obamacare, such maneuvering may even lead to one or more small increases in borrowing authority.

The more likely case, however, is that the Treasurys cash which now stands at $168 billion will run-out before they get to a stop-gap debt ceiling increase. That would cause the Treasury to unleash the nuclear tool of spending prioritization and allocation of incoming revenues to the highest uses (debt service, social security payments and military payroll).

Again, the Washington Post story hit exactly what is coming:

One former Treasury official, speaking on the condition of anonymity to discuss sensitive agency deliberations, said officials are now brushing up on options in the crazy drawer.

In past administrations, Treasury officials have designed plans to prioritize payments to government bondholders so that if the government runs short on cash it could avoid defaulting on U.S. debt.

Such a scenario would be very difficult to manage because some bills would either be delayed or not paid making it necessary to prevent an actual default. Prioritizing payments could lead to a spike in interest rates and a stock market crash, analysts have said.

Thats an understatement, if there ever was one. Prioritization and unpaid bills piling up in the Federal agency drawers will cause a thundering shock in both Washington and Wall Street.

Congress would ring with stories about unpaid contractors, delayed grant distributions, furloughed Federal employers, closed national parks, and endless more.

If theres any lesson from the 2008 crisis, its that entitled elites and robo-machines on Wall Street do not cater to a Congress thats not doing their bidding. That became clear when the stock market dropped by upwards of 800 Dow points during the fifteen minute interval when the first TARP vote was being tallied (and voted down).

The non-compliance with Wall Street demands for protecting the credit of the U.S. at all costs and the sight of political disarray in Washington will come as a shock. It will cause panic on Wall Street and an even greater headache for the Donald.

Thats because Trump has trumpeted the 18% rise of the stock market averages since Nov. 8 as an endorsement of his Presidency. Instead, he shouldve punctured the bubble on Day One by demanding Yellens resignation and blaming the crash on the Fed and its enablers.

Having taken the easy strategy of embracing the stock market bubble, Trump will soon face a double whammy of unfair blame. He soon will be blamed for the debt ceiling crisis that he inherited; and nailed for causing the third major stock market crash of this century. Even though it was fostered by a rogue central bank that he has not addressed, let alone subdued.

The WaPo story provides the growing atmospherics, but the real countdown is in the Treasury numbers. Last year the Treasury collected only $595 billion between July 14 and the end of the fiscal year on Sept. 30.

Last years collections during the back 78 days of the fiscal year amounted to $7.6 billion per calendar day. This figure might reach $8 billion per day this year based on the 4.4% year-to-date lift in total tax collections.

Under that math, Washington has now spent $2.6 trillion through the end of May, or about $11 billion per calendar day. So call the cash burn rate $3 billion per day, and compute the inception of crisis as follows.

That makes 50-60 days of cash left, at most. Then comes the first great fiscal temblor of the new era.

The first round of prioritization and allocation will only be the precursor. It will come when Senator Schumer stands with a hapless Donald Trump in the Rose Garden announcing that the debt ceiling will be increased enough to get through the November 2018 election. Perhaps the Wall Street robo-machines will then be reprogrammed, finally.

At that point there will be no dip to buy. The political and fiscal crisis will become a permanent disaster in the Imperial City and the dip on Wall Street will become an extended cavern.

As all school boys know, the original Waterloo decisively changed the course of history.

So will this one.

Regards, David Stockman forThe Daily Reckoning

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The Imperial City's Fiscal Waterloo - Daily Reckoning