August 2 – Hard Cap or Soft?

August 2 – Hard Cap or Soft?
July 5, 2011
Bob Eisenbeis


Treasury Secretary Geithner has indicated that no options for avoiding a default by the US will be available after August 2. Is this really a hard cap or simply a way of holding the Congress’ feet to the fire to get an extension of the debt ceiling? It is now widely understood and has been reported in the press that the US government has much greater flexibility in paying its debts than most creditors have. In fact, the Treasury has the discretion and authority to determine which obligations will be paid, should Congress fail to raise the debt limit and funds are inadequate to pay outstanding debts. The operable authority was articulated in a 1985 GAO response to a question from then-Senator Bob Packwood, chairman of the Senate Finance Committee, who asked whether the Treasury had the authority to prioritize the order in which debts are paid if Congress failed to authorize an increase in the federal debt ceiling. The GAO response contained two relevant statements, which are reproduced below:

“It is our [GOA’s] conclusion that the Secretary of the Treasury does have the authority to choose the order in which to pay obligations of the United States.”

“We are aware of no statute or any other basis for concluding that Treasury is required to pay outstanding obligations in the order in which they are presented for payment unless it chooses to do so. Treasury is free to liquidate obligations in any order it finds will best serve the interests of the United States.”

Since the Congress failed to pass an increase in the debt ceiling when the deadline was reached, that authority is now operative. So who might not get paid?

Looking at who holds US Treasury debt, the most recent ranking shows that approximately 41% of the public debt is now held by the Federal Reserve and other intergovernmental agencies. China holds 14% and now ranks second behind the Federal Reserve, which holds about 16% of the debt. So, as a first cut, the Treasury could decide simply not to pay interest or principal due to the intergovernmental holders of debt. How much time would this buy?

In the month of May Treasury receipts were in deficit by about $58 billion. Of total outlays of $232 billion, $31 billion was interest payments on the public debt. If one assumes that 41% is interest on intra-governmental debt, then deferring payment would save at least $14 billion, plus adjustments for not redeeming maturing issues held intra-governmentally. This would still leave a hole of about $44 billion. But the Treasury is presently holding deposits totaling $110 billion at the Fed, which it could use to fill part of the hole. Furthermore, in terms of potential principal deferrals, the Fed holds about $30 billion in securities maturing within 90 days and another $101 billion maturing between 91 days to one year. Then, too, the Treasury holds slightly over $100 billion in MBS that it could sell to raise additional funds.

But there are other creative options that the Treasury might use, and these center around gold. The Treasury could simply sell gold, which it has the legal authority to do. At current prices this could bring in about $389 billion of revenue. However, a sale of gold would also require redemption of gold certificates held by the Federal Reserve. But there are other, more creative ways that the Treasury might reap the benefits of a gold sale, without actually selling gold itself. For example, the Federal Reserve presently is carrying the value of the gold certificates it holds on its books at $11.041 billion, reflecting the price of $42.22 per ounce set under the Par Value Modification Act. Should Congress authorize a change in the par value of gold to its current market price of about $1487.00 per oz., the Fed’s gold certificates would be revalued at about $389 billion. Section 7 of the Gold Reserve Act of 1934 provides that in the event of a revaluation of the Federal Reserve’s gold certificates, the capital gain accrue to the Treasury and not to the Federal Reserve. Hence, the Treasury’s account at the Fed, and recorded government revenues, would increase by $389 billion. This would bring the Treasury’s deposits at the Fed to nearly half a trillion dollars or more. These are funds that the Treasury could then use to settle debts. Note that the revaluation would not increase the federal debt, nor would it require the actual sale of gold. It would however require an act of Congress. However, given the desire to buy time, it is hard to see Congress offering much resistance to passage of an accounting gimmick that has only revenue and no debt implications.

Now, some of these options may already be embedded in the Treasury’s calculation that Aug 2 is a hard deadline. But the kinds of monthly deficits that would follow seem relatively small when compared to the potential resources that could be tapped if there was a desire to do so. So, saying that August 2 is a hard cap may simply be a way of trying to force decisions, when there may be several more months more of flexibility to draw upon if a solution seems near.

As one wades through the deficit issues and searches for available funds, the stark reality is that the main problem is spending. Moreover, the problems are increasingly associated with entitlement programs that were not adequately funded and only promise to grow even larger. It is interesting, for example, that the budget of Health and Human Services now exceeds that of the Defense Department. Increasing taxes and raising the debt limit may seem like simple solutions. But in reality these options are “kick-the-can-down-the-road” maneuvers that look distressingly like the Europeans’ approach to their fiscal problems.


Bob Eisenbeis is Cumberland’s Chief Monetary Economist. Prior to joining Cumberland Advisors he was the Executive Vice President and Director of Research at the Federal Reserve Bank of Atlanta. Bob is presently a member of the U.S. Shadow Financial Regulatory Committee and the Financial Economist Roundtable. His bio is found at He may be reached at

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