Ken Fisher on Falling Off a Cliff and Hitting a Ceiling

Our boss, Ken Fisher, frequently reminds us that political biases are dangerous when it comes to capital markets—they blind you to the fundamental forces behind stocks. With that in mind, our political commentary is non-ideological by design. We prefer neither party, and history has shown neither is consistently better for stocks. Our goal is to determine how political factors may impact future stock direction, free from an ideological framework.

As fiscal cliff clocks continue quietly counting down, Washington histrionics approached cacophony Thursday, with talks veering toward the debt ceiling. You see, the agreement ending the debt-ceiling debate in 2011 not only created the Super(fail) Committee, it increased the debt ceiling to a point estimated to be reached in the next few months (read: just after the recent election). And this has drawn the ire of some already. But perhaps even more than the fiscal cliff, the debt ceiling is a mere political machination unlikely to derail the global economy and bull market.

The US Treasury currently estimates we’ll hit the country’s $16.4 trillion debt ceiling in early February 2013 (though these dates frequently change as the Treasury often finds cash in the couch cushions or a $20 in the laundry). And it seems political posturing is underway already. Released earlier this week, President Obama’s initial fiscal cliff plan included a request to end Congressional approval to raise the debt ceiling. Recall, up until World War I, the US government needed congressional approval to borrow money to finance any operation. To facilitate paying for World War I costs, Congress passed the Second Liberty Bond Act in 1917, codifying an overall US Treasury debt limit. The goal was to free Congress from what was seen as an arbitrary approval measure. Recall, Congress itself passes a budget and decides what actually gets spent. The US Treasury simply issues debt when the country’s expenses exceed revenues.

For much of the 20^th century, Congress passed debt ceiling raises with a bipartisan rubber stamp. However, in the mid-1950’s, raising the debt ceiling began to become more of a political wedge—with many politicians using the threat of hitting the debt ceiling (thereby preventing the government from raising new debt) to gain concessions on often unrelated legislation from the other party. Thus, what began as a way to ease the congressional burden of approving debt, became a political tool for parties to leverage their will (and thereby curry like-minded voters favor). And it’s a story we’ve seen play out nearly the same way 91 times since 1940. Eleven times in the last decade alone.

Obama’s proposal to scrap the congressional approval mandate on the debt-ceiling was actually borrowed from Senate Republican Leader Mitch McConnell, who first proposed it in last year’s debt-ceiling talks. The plan, hailed as the “McConnell Provision,” gives the president the ability to notify Congress of a pending hike to the debt limit. Congress would then have the opportunity to pass a resolution disapproving the hike. If they fail, the increase goes through automatically. If they succeed, the president would still have veto power, so a two-thirds majority would actually be needed to block any increase—a high bar to reach on any topic in Congress.

Unsurprisingly, Republican leaders balked at Obama’s proposal—unwilling to give up control on such a valuable bargaining chip and arguing for more cuts to spending. Obama hardened his position too though, stating no fiscal cliff deal would be possible without some resolution on the debt ceiling. But while we expect salvos on the fiscal cliff and debt ceiling to continue to nearly the last minute, in our view, it’s highly likely Congress finds enough compromise to kick the can (very likely both cans) down the line. After all, these are powerful political wedge issues for use in 2014’s mid-term election fundraising and politicking.

Even if politicians don’t manage to reach a compromise before December 31^st (or February 2013 in the debt ceiling’s case), history shows similar situations lack real punch to derail the global economy and markets. With the fiscal cliff, it’s at least true that if the can isn’t kicked, taxes will rise and spending will be cut. (Though, as Ken Fisher has pointed out, the impact isn’t nearly as dire as many think—the cliff is much more of a rolling plain in that regard.) But the debt ceiling, although much political hay will be made on this topic between now and February 2013, has even fewer real consequences. You see, even if the self-imposed ceiling isn’t raised, the US doesn’t automatically default on its debt service obligations. In 2011, debt service costs were a mere 1.4% of GDP—tiny! They account for only about 9.9% of tax revenue in the same period. So while the government might have to turn the Congressional heaters a little lower or curtail tours in the Capitol, it’s likely our debt obligations still get paid. So, let the countdown clocks wind down—as it pertains to cliffs and ceilings in Washington, it seems the rhetoric far exceeds the reality.