If you’ve seen the 1955 movie Rebel Without a Cause, you’ll remember the iconic scene.
Dean plays troubled teen Jim Stark. He’s clashed with a local delinquent called Buzz Gunderson. And Buzz has challenged him to a game of “Chicken Run” at a seaside cliff.
The two teens steal cars… point them toward the abyss… and put the pedal to the metal.
The idea is to see who jumps out of his car first, proving the other player “chicken” in the game.
Neither Jim nor Buzz is planning on dying. They just want to prove a point.
But as his car races toward the cliff, a buckle on the sleeve of Buzz’s leather jacket gets caught in the door handle… he’s unable to jump from the car… and he plunges to his death.
It’s no surprise this kind of game can end in tragedy…
The best outcome for both players in a game of Chicken Run is to stay in their cars for as long as possible. That’s how they prove their bravery and win the game.
Flying over the cliff edge is the worst outcome.
But each player must risk the worst outcome to secure the best outcome. So, disaster is always close at hand.
That’s worth thinking about for us as investors right now. Because the fight over the debt ceiling in Washington is a game of Chicken Run with politicians behind the wheel.
Neither side wants to crash the economy by triggering a default on U.S. government debt. But each side wants the other to jump first.
And like what happened to Buzz in the movie… that could lead to a tragic accident.
Only this time, the injured party could be the U.S. economy… U.S. stock and bond markets… and your nest egg.
So today, let’s look at how the debt ceiling fight could end in tragedy… what it means for your portfolio… and how you can shield your wealth if politicians drive the economy off a cliff.
The debt ceiling is a quirk of history…
Before 1917, it didn’t exist. Because up to that point, Congress had complete authority over each new bond the Treasury issued.
But to give the Treasury more leeway, and help fund America’s involvement in World War I, it allowed the Treasury to issue bonds at its discretion providing it didn’t breach a pre-agreed limit – or ceiling – on the total debt.
And this ceiling doesn’t automatically go up as Congress approves new spending. It must vote to raise it.
That gives Congress the power to force the government to roll back its spending commitments.
And if Congress doesn’t approve a higher debt ceiling, the federal government has no choice but to default on its debt. Tax receipts alone aren’t enough to cover its spending commitments plus the interest payments on the debt.
Congress has never gone through with its threat and refused to raise the debt ceiling. So, most folks think it won’t happen this time either.
They could be right. But there are reasons to worry that this time may be different.
This isn’t the most cohesive Congress…
As you’ll recall, Republicans won the House by only a slim majority in the 2022 midterms.
And back in January, it took them four days to cobble together the votes to make Kevin McCarthy Speaker of the House.
During that process, he promised the Freedom Caucus he wouldn’t raise the debt ceiling without forcing spending cuts first.
That’s put Republicans on a collision course with the White House since the start of the year.
Even if McCarthy wants to pass a new debt ceiling limit at the last moment… and avoid default… he may not be able to muster the votes among Republicans in Congress.
He’d have to rely on votes from Democrats to raise the limit… a move that would almost certainly end his tenure as Speaker.
The other player in this game is President Biden. He’s counting on voters blaming Republicans if something goes wrong. So, he’s not budging.
And this sets up exactly the kind of dangerous dynamic that could lead to a nasty accident.
I’m not the only one worried about this political game of Chicken Run…
There are clear signs that investors are worried, too.
Exhibit A is the “spread” – or gap – between the yield on 1-month and 3-month Treasury bills.
Yields and prices move in opposite directions in the bond market. So, when the yield on a bond rising, its price is falling.
Take a look…
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Source: eSignal
Normally, 1-month and 3-month T-bills are among the safest investments in the world.
So, the spike in the 3-year yield (and the accompanying fall in the prices) means investors are fretting something bad will happen between one and three months from now.
And that’s when the debt ceiling clash will likely come to a head.
According to Goldman Sachs, we’re looking at a deadline sometime in July.
Exhibit “B” is the soaring cost of insuring U.S. government debt…
It’s all in this next chart. It’s of the cost of the credit default swap contract on the debt.
As the name suggests credit default swaps allow you to swap the risk of a default with another party.
Over the past decade or so, it hasn’t cost much to insure U.S. government debt. The only spike was during the pandemic.
But this year, the cost of insurance has skyrocketed. It’s now higher than it was following the collapse of Lehman Brothers in 2008 and during the Tea Party-inspired debt ceiling fight in 2011.
None of this means a debt default by Uncle Sam is inevitable…
But games of Chicken Run – whether in a speeding car or a legislative chamber – are risky.
Even if nobody wants to run off a cliff… the dynamics of the game mean this is often the result.
And there’s virtually no scenario in which this doesn’t go down to the wire.
So, adding some portfolio protection is a wise move.
I wrote to you on Monday about how bitcoin is one potential winner if Congress doesn’t raise the debt ceiling.
During the worst of the banking crisis last month, it proved a reliable alternative to leaving your money on deposit in the bank.
T-bills are another supposedly safe place to park your cash. If investors start to see them at risk from a default, expect more inflows into bitcoin.
Another likely winner in a debt ceiling fiasco is gold…
If you’ve been following along with us for some time, you’ll know we recommend all readers own some gold as a “chaos hedge.”
As I’ve been showing you bank deposit and Treasury bonds are IOUs. Their value relies on someone else’s promise to pay.
If the entity making the promise runs into trouble… you could be left high and dry.
With gold it’s different. It doesn’t matter who goes bankrupt or defaults, your wealth is safe.
The safest form of gold is physical bars or coins…
You can store these in a safe location on your property.
But if that’s not for you, the next best thing is to own physical gold through the Sprott Physical Gold Trust (PHYS).
Its shares are fully backed by physical gold and can be redeemed for the metal.
Sprott stores its gold in a fully allocated account at the Royal Canadian Mint. That means it holds titles to specific serialized gold bars. So even if the fund goes out business your gold is in your name.
How high could gold go?
It’s hard to say, because the U.S. has never defaulted on its debt before.
And U.S. Treasury bonds are the bedrock layer of not only the U.S., but the global financial system.
A default on the debt would reduce the U.S. to banana republic status… and have a potentially worse impact on the economy than the near-collapse of the banking system in 2008.
Between the collapse of Lehman Brothers in September 2008 and its peak three years later, gold rose by about 166%.
If the U.S. defaults on its debt… and triggers an even bigger crisis… it could go up by multiples of that amount.
So, keep your eyes on these pages for updates as the situation unfolds.
In the mailbag: “I can honestly say your service is everything you say it is…”
In today’s mailbag, the praise keeps coming in for trading legend Larry Benedict.
As regular readers will know Larry was featured in the 2012 book Hedge Fund Market Wizards. It featured a series of in-depth interviews with the world’s greatest hedge fund managers.
And Larry was featured alongside Ray Dalio – the manager of the world’s largest hedge fund, Bridgewater Associates – and Ed Thorp. He’s the MIT math whizz who had only one losing year between 1973 and 1991 at his hedge fund, Princeton Newport Partners.
And Larry outdid even Thorp’s streak. He didn’t have a single losing year as a trader from 1990 to 2010… a record that’s unsurpassed as far as I know.
And lately, this year at his S&P Trader advisory, Larry’s knocked it out of the park.
It’s focused on an options trading strategy Larry used at his hedge fund.
The gains on this strategy depend on your starting balance. But assuming a starting balance of $25,000, Larry’s given his readers the chance to make a 48% return so far in 2023.
And he regularly gets thank you notes from happy subscribers…
I have traded the markets for years. Ran my own retail book for Hutton, Prudential, and Morgan Stanley. I can honestly say that your service is everything you say it is, no hype, just the facts and the results honest and real. Thank-you Sir, I am a subscriber for life.
– Marc D.
I have been receiving your trades in the S&P Trader service for 5 weeks now…
I am aware you are regarded as a Market Wizard, and a most successful hedge fund manager for many years, but one truly has to put these trades on, and watch them work out in real time to appreciate it. It is truly amazing.
I am amazed every day, and am excited every day, to put on the next recommendation, and observe it work out.
– Jon B.
Write us your own success story trading with Larry at [email protected].
Regards,
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Chris Lowe
Editor, The Daily Cut