Eliminating the Debt Ceiling Wouldn’t Cause Interest Rates to Surge

I just read this at Euro Pacific Capital, Peter Schiff’s company.  He says we should eliminate the debt ceiling so our creditors can cut us off:

“Such a development may be the shock therapy our creditors need to finally cut us off for good. If that occurs, interest rates in the United States could finally rise to more rational levels. A significant increase in the cost of borrowing will create the mother of all fiscal cliffs. It’s too bad that Tim Geithner can’t see that one coming.”

This is not correct.  Schiff misunderstands the design of our monetary system.  Our monetary system is designed in such a manner that the government harnesses the banks as funding agents.  Since Primary Dealers are required to bid at Treasury auctions there is no concern over Dealers showing up to place bids and make “reasonable markets” in US government bonds.  The  NY Fed mandates this and ensures that they get kicked out of the club if they don’t comply.   (This doesn’t mean inflation couldn’t result in currency and bond rejection!).

And interest rates on government bonds are a function of Fed policy (which is a function of economic expectations), not what these banks are willing to pay for the bonds (again, they must make reasonable markets in government bonds as mandated by the Fed).  So, long rates are a function of short rates which are a function of the Fed’s future economic expectations.  If inflation worries were really high the Fed would raise short rates and long rates would surge (long bonds would tank as the traders would likely anticipate the change in policy).  The Fed chases economic performance (yes, at times making bad predictions) and the banks front-run the Fed.  That’s how fixed income traders work.  Obviously, Schiff doesn’t understand the trading dynamics at work here nor does he understand the monetary dynamics.

It’s that simple.  There will be no comeuppance in yields if the government eliminated the debt ceiling and the Fed kept rates at zero due to low inflation fears.  Just like the market wasn’t worried about QE2 ending (and all the persistent fear mongering about rates surging) or the S&P downgrade or the debt ceiling debates last year.  Yields remained low through all of these supposedly disastrous events.  We’ve literally heard this same prediction based on the same false understanding time and time again.


Got a comment or question about this post? Feel free to use the Ask Cullen section, leave a comment in the forum or send me a message on Twitter.

Cullen Roche

Mr. Roche is the Founder of Orcam Financial Group, LLC. Orcam is a financial services firm offering research, private advisory, institutional consulting and educational services.

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  • KB

    What would happent to interest rates is difficult to predict, but I also think they will not surge, at least in the short term.
    However, if the ceiling is removed, there would likely be another downgrade. If UStres cease to be AAA, it would drastically change the whole rating based investment approach, likely starting from Basel II/III. Can you predict the consequence of such change?

  • SS

    Cullen, being right doesn’t matter. Yelling louder and sounding scarier than the next guy is what works. You’d be a lot more famous if you figured this out sooner rather than later!

  • Geoff

    I agree with Schifty about one thing. We should eliminate the f-ing debt ceiling.

  • InBernakeWeTrust

    Schiff is obviously forgetting that the Fed now purchases over 90% of all the new debt issuance. As long as that is the case the yield won’t go above 2%. Until we get the hyperinflation schiff has been talking about since ’07 he shouldn’t be allowed to comment on economics.


  • Achaeron

    Eliminating the debt ceiling would have no impact on yields. It was originally created as a safeguard for preventing Treasury from issuing too much debt. Given current transparency, there is no chance of this happening. The debt ceiling is simply an impediment and outdated concept, the reaching of which creates additional volatility.

  • krb


    Here we go again……it’s like holding a conversation in an echo chamber the way this argument keeps going in circles and you choose to ignore the possible real-world explanations for Bernanke, Schiff, et.al. behavior when you claim “they don’t understand the design of our monetary system….”. I’m indebted to you for educating me on our monetary system and you have totally convinced me of the accuracy of your description. And it would be warranted for you to state that I and other amateur financial thinkers on your blog, or our conflicted politicians (more amateur financial thinkers!), “don’t understand the monetary system”. But to make that claim about Schiff, or as you have in the past, Bernanke, in my view could just possibly be a little naive. In my view, it is very possible, even likely, they understand it very clearly, but have other agendas.

    I first want to say I’m simply offering a different perspective, and that this isn’t a defense of either man….I believe Bernanke’s behavior in bailing out bank wrong doers at the expense of the middle/lower classes and retirees borders on the criminal, but I would never claim the guy isn’t brilliant or doesn’t understand the fundamentals of the monetary system. Do you really believe Bernanke doesn’t understand there is no transmission mechanism for his bank handouts to reach, and revive, the economy? I think he understands it very well, but his “economic revival” pronouncements are simply a diversion for his real purpose of keeping wall street banks upright……the public will go along with attempts to revive the economy, they’d never go along with the perpetual bank handouts he’s actually pursuing.

    I think the backdrop for Schiff’s pronouncements is less clear cut, but no less understandable. He wants clients who open accounts, buy foreign assets and gold, so he sells his view of the future. Do you really believe he doesn’t understand that interest rates will remain low so long as the fed acts to force them to remain low? I think he represents the crowd looking at “where does it go from here”, while you represent the “here is what we have today” crowd……I think his silliest behavior is trying to attach time-frames, not that his forecasts couldn’t eventually come to pass.

    My focus is 10 yr issuance and higher, the issuance more likely bought for investment purposes with interest rate risk……issuance lower than that is complicated by the many non-investment reasons different entities need to buy and sell US bonds and notes. You persistently argue we will never have a shortage of buyers and the associated interest rate risk because the primary dealers HAVE to make a market……..well, a reasonable argument can be made that that will last only as long as there is a deep resale market…..and there are already signs of large historical buyers reducing their purchases of 10 yr and higher issuance…..maybe that dwindling interest stops, maybe it doesn’t. Of course, the fed could quickly step in to buy up what the rest of the resale market no longer wants….they’re buying 90% of it already after all. Now, you’ve argued that they’re buying up 90% of issuance is NOT a sign of a shrinking resale market or reflect a need to monetize for lack of other buyers. I agree with you….for now. I believe their bank bailout agenda forces them to buy almost all the issuance in order to provide handout bank reserves and restore bank health. But at these low rates and huge supply of issuance is it unreasonable to foresee a day when non-fed buyers begin to balk at buying up the 10 yr and higher issuance from the PDs?…….it’s not unreasonable to me…….and if/when the fed HAS to be the resale buyer instead of CHOOSING to be the resale buyer, a lot of actions that you claim can’t happen could possibly begin happening pretty quickly. And it doesn’t seem like a sequence of events out of some science fiction novel either. Under current circumstances and govt/fed leadership, seeing it happen wouldn’t be much surprise at all, and Schiff’s view of the future could come true……I do NOT think its because he “doesn’t understand it”. Sorry for length…….its just another perspective. Thanks for your patience, krb

  • http://www.orcamgroup.com Cullen Roche


    I advise a number of large funds on this stuff. Even my retail research through Orcam deals with this stuff specifically. That work is all very forward looking. It is the nexus between macro outlooks and investment strategy. It has to be or the clients don’t make money. So no, I am not simply describing what is. I am also describing where things are going.

    I can’t provide specific investment advice here, but like Schiff, I have clients who I do that for. So my work is very much forward looking. In fact, I am an investor before I am a macro theoretician. And yes, I think Schiff does not connect the dots on all of this.

  • Anon

    “Do you really believe he doesn’t understand that interest rates will remain low so long as the fed acts to force them to remain low?”

    Yes – I do think Schiff doesn’t understand this! I think he believes that the current situation/yields etc are some kind of abberation that shouldn’t be happening based on his views of how things are supposed to work. I believe he feels that at some point soon, without any change in the underlying economic outlook, the “system” is going to implode and we go back to some gold standard.

  • Geoff


    Apologies for not engaging you previously, but I was extremely busy at the time. Regarding the Fed’s “real purpose”, I’m not sure if Bernanke has a secret agenda, but you are right that he certainly caters to the banks. The Fed has its official public purpose mandates of price stability and employment, but it also has to cater to the banks which of course are private purpose entities. As Cullen has said before, this odd mix of private and public purposes puts the Fed in a very awkward situation with inherent conflicts of interest. This situation is not ideal, but personally I wouldn’t call it a secret, or evil, agenda. Perhaps I’m naive (to use your word), but I see Bernanke as a pretty likeable guy who is doing his best to satisfy a number of competing interests.

  • http://www.orcamgroup.com Cullen Roche

    Totally agree Geoff. The Fed is a middleman whose primary master is the banks. The Fed system, by design, caters to the banks to try to sustain a healthy private competitive banking process. But the Fed also serves another master – the govt. But in trying to serve the govt it must directly deal with its other master – the banks. And the banks are where it achieves policy. So the Fed has this very bizarre conflict of interest where it must prop up the banks in order to achieve public purpose. It’s not evil. It’s certainly not a secret. And the men and women who work at the Fed are certainly not evil master minds trying to wreck the world. They’re just in a tough spot with regards to politics because they’re getting pulled at by both of their masters. And they ultimately HAVE to serve the banking masters because that’s where policy is implemented. I am not saying you or anyone else has to like it. But we shouldn’t misrepresent what this design structure really is. And what it’s not is some great big conspiracy to enrich bankers at the expense of the little guy. In fact, you could argue that the Fed is the last refuge protecting our banking system from being fully nationalized. The small govt people should love the Fed. For some reason, they hate it.

  • Cowpoke

    Tonight Church Of Monetary Preaching is brought to by:

    Matthew 6:24:
    “No one can serve two masters. Either he will hate the one and love the other, or he will be devoted to the one and despise the other. You cannot serve both God and Money.”

    Luke 16:13:
    “No servant can serve two masters; for either he will hate the one and love the other, or else he will be devoted to one and despise the other. You cannot serve God and wealth.”

    This is kinda an Ironic situation the FED is put in as you say. For these are human created and ran institutions that still have intrinsic human nature philosophical guidelines to follow.
    In the secular realm, Govt is God and the Banks are Money.
    So Bernanke really is caught between the proverbial rock and a hard place.

    Let us all pray his political wallet makes the correct choices.

    And the people in the crowed said…Amen :)

  • krb

    Cullen, Anon, Geoff, Cowpoke,

    Great comments all…..I very much appreciate it!

    I don’t get upset with Schiff like others do because I’m aware of his conflicts of interest….little different than the financial advisor/salespeople from Goldman, JPM, etc who try to persuade the public by forecasting the future…..so buyer beware…..and we don’t call out all the other conflicted commentary.

    I view Bernanke differently…..he’s a public figure who portrays his role as that of taking care of us all, which couldn’t be further from the truth. First, I have never used the word “conspiracy”…..I have described the fact that his public explanations, first it was the wealth effect and now it’s raising employment and later it will be something else, are NOT what he is actually doing or even capable of doing……I thought calling him a liar would be a little boorish. If he’s the nice guy and altruistic public servant you portray him to be, then he should come out and make clear what he is actually doing and defend it……..Cullen, you were the very person who educated me to the fact there is no transmission mechanism for him to do what he claims to be doing…..what’s the point of dancing around the topic…..call him out? If the goal of this site is education, misleading the public, or worse yet, misleading the legislative body about what he’s doing seems counterproductive and deserves more wrath than we seem willing to give him.

    Sincerely though, I DO appreciate the discussion and different viewpoints you guys/gals offer! krb

  • LVG
  • http://www.orcamgroup.com Cullen Roche

    Of course they are. MMT would be better off if they spent less time attacking other people and more time trying to find some allies. But I am a broken record telling them that so who cares?

  • beowulf

    “What would happent to interest rates is difficult to predict, but I also think they will not surge, at least in the short term.”

    I have two shocking revelations for you: Pro restling matches are won by whoever Vince McMahon wants to win and interest rates are whatever the Federal Reserve wants them to be. And they’ve said they’re keeping Fed Funds target from 0 to 0.25% at least through 2015.

    “If UStres cease to be AAA, it would drastically change the whole rating based investment approach, likely starting from Basel II/III. Can you predict the consequence of such change?”

    Look, There’s nothing more stable on this plane than the US Government, Simplest way to put this… Go look at a world map. The areas marked in blue show the parts of the globe controlled by the US Navy. Is there any AAA investment in the world that would still be AAA in the wake of whatever would have to happen for the US Government to collapse? If Uncle Sam is not AAA, then nothing is, the markets and the regulators (even the ones who aren’t employees of the US Government) know this and will act accordingly.

    Its only because everyone knows the ratings are meaningless that the rating agencies are in no danger of criminal prosecution. If the federales were genuinely worried about it, they could shut down rating agencies that downgrade its debt and then arrest its employees and directors on conspiracy to defraud the United States.

  • beowulf

    “But at these low rates and huge supply of issuance is it unreasonable to foresee a day when non-fed buyers begin to balk at buying up the 10 yr and higher issuance from the PDs?”

    T-bonds are not an entitlement. Tsy could stop issuing anything other than 3 month T-bills and would keep on keeping on just fine (and actually save a bundle on net interest). The government provides long bonds as a service to investors and not because it needs brave investors to step forward like the defenders of the Alamo, willing to risk it all to buy, errr– risk-free long bonds. Sometimes people forget this. :o)

  • Geoff

    Beo, if T-bonds were eliminated, it would be interesting to see how the rest of the bond market would react. Currently, most of the US non T-bond market, such as investment grade corporate bonds, are priced off Treasuries, i.e. they are quoted in spread over Treasuries. I guess they would have to find a new benchmark! Perhaps the highest quality/rated corps like J&J, GE and Walmart would become the new benchmarks. Personally, I think that would be a positive development. Pricing the private bond market off the public bond market (or a currency user off a currency issuer), as is done now, doesn’t make much cents :)

  • InvestorX

    CR “the Fed has this very bizarre conflict of interest where it must prop up the banks in order to achieve public purpose. It’s not evil. It’s certainly not a secret. And the men and women who work at the Fed are certainly not evil master minds trying to wreck the world.”

    This is naive / apologist. Even if the Fed and his staffers are not “evil”, they are pragmatic obedient servants in a system put there from the banks (the Fed’s charter was written by lobbyists – guess who) for the banks. So ok – they are not evil, they are just stupid and opportunistic enough to serve evil.

  • thedude1969

    Cullen, do you have any youtube videos or other testimonials pre-housing crash where you predicted that event?
    Fact is, Schiff was a laughing stock for several years. So was anyone claiming house prices could drop, because everyone thought that was ridiculous, and that such a naysayer was clueless about the way the housing market works. Then one day the markets reverted back to reality with a 50% adjustment to stocks and a 40% adjustment to house prices.
    What makes you think such an “adjustment” can’t happen with Treasuries?

  • leftcoast

    If the debt backed by 23% of global output isn’t AAA, then what is?

  • krb


    Good observation and I have NOT forgot this…..its what I expect to eventually happen, when the “deep and liquid supply of buyers” that no one believes will ever dry up, begins to dry up (non-fed buyers). And when that happens I believe we will begin to see many other things that up to now people have claimed will never happen, begins to happen…..the political, psychological stuff that, heaven forbid, accelerates the loss of faith in a currency……its a slippery slope, in my view.

    As an aside, good luck with things like pension funds, life insurance, etc when “safe” longer term investments go away…..your view that the govt could easily eliminate the higher maturities and we’d go merrily along is a little flip, in my view…….there WILL be consequences.

    Good observation though,beowulf, but be careful what you wish for. Thanks, krb

  • Jay H. Mani

    Its frightening that this guy actually manages money for a living. Not understanding the basics of Fixed Income Trading with regards to Primary Dealer actions is not totally surprising. Schiff has an agenda and his agenda is a Right Wing/Libertarian echo chamber devoid of any type of functional reality. It’s a campaign that wages war on the less fortunate so that the fortunate can continue to rule with autonomy. I don’t know why we continue to listen to these guys and why FOX News and Real News Network continue have them one.

  • KB

    What is AAA is determined by the big three. And then reflected in the leverage rules for various Basels. Call this sand castle system, but it is what it is. Just remove the foundation from this construct and see what happens….