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The Retractable (Debt) Ceiling

Posted on May 7, 2023June 30, 2023 by Corrin Gibbs-Burke

The clock is ticking on US debt ceiling negotiations. Treasury Secretary Yellen informed Congress that cash balances are estimated to run out by early June, the socalled X-datei. With the deadline fast approaching, markets are sending signals about investor concerns. Treasury bills with maturity dates in mid-summer are seeing higher yields.While there is no playbook on how this showdown will unfold, sadly, this is not our first rodeo either.

We have been here before

Since the enactment of the debt ceiling in 1917, Congress has voted 102 times to either raise or suspend the limitii. This has taken place under both Democrat and Republican control.That’s not to say things have gone smoothly in the past either. In 2011, the debt ceiling debate went so far that the credit rating agency, Standard & Poor’s, downgraded the USS credit rating to AA+ from AAAiii. Standard & Poor’s cited the growing deficit and the prolonged debate as the reasons for the downgrade.In 2013 and 2018, debt ceiling standoffs led to government shutdowns. Each standoff, showdown, and shutdown led to short-term market disruptions for days or weeks and subsequently recovered.

Is this time different?

It feels that the political debate today is even more combative, with the potential for a stalemate ever greater than in the past. Sadly, that is not a new development in Washington. However, the one thing separating today’s debt debate from those of the past is the larger-than-ever national debt. US debt at $31.4 trillion, now stands at 120% of gross domestic product as of December 2022 and is projected to increase in the futureiv. The silver lining is that despite higher debt, the interest cost on our debt is lower than the outlays in the 1980s and 1990sv. Nonetheless, the potential costs ahead are higher than in years past.

What are the paths ahead?

If a deal is reached before the X date, Congress could suspend the debt ceiling for a short time to coincide with the end of the fiscal year. Alternately given the upcoming election year, the most likely scenario is a last-minute agreement to raise the debt ceiling. If a deal is not reached and all of the Treasury’s cash balances are drawn, the federal government will be forced to rely on incoming revenues to pay its bill.This would require a prioritization in payments with principal and interest payments to bondholders likely to continue while other payments like government salaries and social security benefits could be interrupted. If a bond payment is missed or delayed, that would constitute a technical default. The chances for a technical default, while not zero, remain low given the potential implications.A default is not a winning political outcome despite the hardline posturing from both parties to date. A default would mostly likely trigger a downgrade of US debt, increase the cost of borrowing, pressure the US dollar’s reserve currency status, and disrupt short-term funding in financial markets.The subsequent market fallout will likely apply significant pressure on lawmakers to find a quick resolution.

What should investors do?

Understandably, the debt ceiling drama has investors on edge. Investors should resist the urge to make impulsive portfolio decisions solely based on debt ceiling risks. Instead, they should remain focused on long-term goals and rely on diversification within their portfolio. For instance, consider precious metals like gold, currencies like the Japanese yen or, the Swiss franc, or even international equities where appropriate. However, given the potential for increased market volatility, investors should ensure they have ample liquidity to meet near-term spending needs. Finally, looking past the near-term volatility, history suggests that stock markets tend to rebound shortly following the resolution of the US debt ceiling crises.

As history is our guide, let’s hope the retractable (debt) ceiling is raised while finding a longer-term solution to the escalating debt and deficit.

Key Takeaways

The government’s borrowing limit is estimated to run out by early June.
Investors should prepare for potential volatility as increased partisanship in Congress will potentially only be resolved at the final hour.
Investors should not make impulsive portfolio decisions solely based on debt ceiling risks.

i https://home.treasury.gov/news/press-releases/jy1454

ii https://www.americanprogress.org/article/congress-must-raise-the-debt-ceiling/

iii https://www.cnbc.com/2011/08/06/sp-downgrades-us-credit-rating-to-aaplus.html

ivhttps://fred.stlouisfed.org/series/GFDEGDQ188S

v https://fred.stlouisfed.org/series/FYOIGDA188S

Important Information

This is for informational purposes only, is not a solicitation, and should not be considered investment, legal or tax advice. The information in this report has been drawn from sources believed to be reliable, but its accuracy is not guaranteed, and is subject to change. Investors seeking more information should contact their financial advisor. Financial advisors may seek more information by contacting AssetMark at 800-664-5345.

Investing involves risk, including the possible loss of principal. Past performance does not guarantee future results.Asset allocation cannot eliminate the risk of fluctuating prices and uncertain returns. There is no guarantee that a diversified portfolio will outperform a non-diversified portfolio. No investment strategy, such as asset allocation, can guarantee a profit or protect against loss. Actual client results will vary based on investment selection, timing, market conditions, and tax situation. It is not possible to invest directly in an index. Indexes are unmanaged, do not incur management fees, costs and expenses and cannot be invested in directly. Index performance assumes the reinvestment of dividends.

Investments in equities, bonds, options, and other securities, whether held individually or through mutual funds and exchange traded funds, can decline significantly in response to adverse market conditions, company-specific events, changes in exchange rates, and domestic, international, economic, and political developments.

Bloomberg® and the referenced Bloomberg Index are service marks of Bloomberg Finance L.P. and its affiliates, (collectively, “Bloomberg”) and are used under license. Bloomberg does not approve or endorse this material, nor guarantees the accuracy or completeness of any information herein. Bloomberg and AssetMark, Inc. are separate and unaffiliated companies.

AssetMark, Inc. is an investment adviser registered with the U.S. Securities and Exchange Commission.

AssetMark, Inc.

1655 Grant Street10thFloorConcord, CA 94520-2445800-664-5345

Demise of the US Dollar: Greatly Exaggerated or Destiny?

Posted on April 10, 2023June 30, 2023 by Corrin Gibbs-Burke

Dollar Fears

After a decade of relative strength, the US dollar has declined sharply over the last six months. This has coincided with media reports that the world may reduce dollar usage. We examine the US dollar from two perspectives – as a medium of global trade and as a reserve currency. Short-term, we see a mixed environment for the greenback; longer-term, the effects of dedollarization are likely to be both positive and negative.

What is the Petrodollar system?

The Petrodollar system was created in the 1970s by the United States and Saudi Arabia. The system is an agreement between the US and OPEC1, which among other things2, requires OPEC member countries to use the US dollar when they sell oil. The Petrodollar has been dented over the last several years, as some non-OPEC oilproducing countries have been transacting in currencies other than the US dollar3. Earlier this year, Saudi Arabia made headlines when it announced it was open to selling oil in non-US dollar currencies. More recently, several non-OPEC countries4 announced they have been discussing an alternative currency to the Petrodollar. Clearly, if the Petrodollar falls, that would mean a sea change in global politics and economics. However, settling on an alternative currency for oil transactions would be very challenging.

Any alternative currency would need to be relatively stable and easily exchangeable for other currencies or assets. Surprisingly, the number of currencies that meet these criteria is relatively small. Not coincidentally, these are some of the same characteristics of reserve currencies.

What is a reserve currency?

A reserve currency is a currency that is widely held by central banks and other institutions. These entities hold reserves to help manage exchange rates and facilitate global trade. The four largest reserve currencies are the US dollar (58% of global reserves), the euro (20%), the Japanese yen (6%), and the British pound (5%)5.

While there are no official criteria for reserve currency status, reserve currencies tend to have the following:

• Stable economies and political systems: reserve currencies should be effective stores of value (i.e., have relatively stable exchange rates).

• Free capital flows: reserve currencies should be easily exchanged for another currency or asset and easily moved from one country to another.

• Robust financial system: reserve currencies should have liquid, transparent, and well-governed capital markets in which to invest, including a deep sovereign bond market.

While the Petrodollar system creates a natural demand for US dollars, the US also scores highly on the three criteria above. In our view, the most significant risks to the US dollar’s reserve status are not external factors but internal factors relating to reserve currency criteria. Specifically, the stability of our political system has been called into question with issues around the peaceful transfer of power and the ability of our government to effectively legislate.

Similarly, concerns about high government debt levels (and a potential government shutdown this year) have raised concerns about the stability of our economy.

De-dollarization?

Given the developments with the Petrodollar and the concerns mentioned above, the world is likely to diversify some of its exposure away from the US dollar. However, we believe the move is likely to be slow for three reasons.

First, the dollar remains the dominant currency for international trade. Outside of Europe, over 70% of exports are conducted in dollars. This “network effect” is very slow to change. Secondly, the dollar is also the dominant currency in global banking, with about 60% of foreign bank deposits and loans denominated in US dollars6.

Lastly, countries’ supply and demand change slowly. Developed nations like the US tend to have higher domestic demand than developing countries, meaning we import more goods than we export7. The US, for example, imports about $1.2 trillion more than we export. This $1.2 trillion gap needs to be invested in US dollar-denominated assets. Currently, no other sovereign bond market is deep enough to handle this level of investment8. Outlook for the US dollar? Near term, the US dollar may weaken for the normal reasons currencies fluctuate in value (differences in interest rates, economic growth, and inflation rates across countries)9, but we don’t see a clear-cut bear case.

Further, the US dollar remains one of the most reliable safe-haven currencies in the world. Longer term, it seems likely that global diversification away from the greenback will reduce demand for US dollars. It is not clear to us if the US economy benefits from a consistently strong dollar. Too much demand for dollars results in lower US interest rates. Persistently low-interest rates tend to facilitate debt accumulation and asset bubbles, while also punishing US savers.

A structurally lower dollar might require a painful adjustment, but several issues impacting the US economy (e.g., the income gap, position of US manufacturers) would likely improve.

Key takeaway

Global diversification away from the US dollar seems likely over time. Shorter-term, we see a mixed environment for the dollar. Longer-term, de-dollarization is likely to be a negative for the dollar; the impact on the US economy, however, will likely be both positive and negative.

1 Organization of Petroleum Exporting Countries

2 Saudi Arabia agreed to sell its oil in US dollars and invest those dollars in US Treasuries, in exchange for US

military support and weapons.

3 Venezuela for example, began accepting euros, Chinese yuan, and other convertible currencies for its oil exports

in 2018, before entering OPEC.

4 Brazil, Russia, India, China, and South Africa

5 While the US dollar share of foreign exchange reserves has declined, the decline has not been dramatic. 10 years

ago, the USD share was 61%. Source: Bank of International Settlements.

6 Source: US Federal Reserve.

7 Conversely, developing economies like China and India tend to produce more than they can consume, so they

export those goods to developed with higher domestic demand, like the US.

8 US Treasury market is about $10 trillion. The Japanese Government Bond market is about $7 trillion (but they

own most of it). All other countries have sovereign bond markets of less than $2 trillion. Source: Bloomberg.

9 Among G-10 currencies, the US dollar ranks 2nd best, 5th best, and 6th best, on relative interest rate, growth, and

inflation rates, but it ranks very low on trade and budget balances.

Important Information

AssetMark, Inc. is an investment adviser registered with the U.S. Securities and Exchange Commission.

AssetMark, Inc.

1655 Grant Street10thFloorConcord, CA 94520-2445800-664-5345

Fed Decision – Aiming for Stability

Posted on March 22, 2023June 30, 2023 by Corrin Gibbs-Burke

The road so far

Over the last two weeks, the FDIC assumed control of Silicon Valley Bank and Signature Bank. Both banks had experienced losses in their fixed-income portfolios and were unable to attract sufficient capital to meet the withdrawals of their depositors1.

In an effort to increase confidence in the banking system, US regulators provided banks with access to capital through several lending facilities. They also guaranteed all of the deposits of the two banks beyond the $250,000 FDIC insured level. A few days later Credit Suisse, the second-largest Swiss bank, experienced its own funding crisis. The Swiss National Bank (the central bank of Switzerland) hastily arranged the sale of Credit Suisse to UBS (the largest bank in Switzerland).

This set the stage for the Fed’s interest rate decision on March 22, 2023. The Fed had already raised by 4.5% over the last year in an effort to lower inflation. This rapid increase in interest rates was a significant driver of the recent stresses in the banking system.

The Fed’s message

The Fed raised interest rates by 0.25%, meeting market expectations. It is likely that they did not want to surprise investors by raising rates more (or less) than expected. A pause in rate hikes could suggest the Fed was extremely worried about financial stability (which would worry many investors), while a larger-than-expected rate hike could suggest the Fed was ignoring financial stability (which would also worry investors).

Chairman Powell opened his statement by pointing out that growth has been “modest” and that job gains had picked up. He then highlighted that the “US banking system is sound and resilient” but stated that recent developments in the banking system would likely result in “tighter credit conditions,” which will weigh on economic activity, hiring, and inflation. In describing future rate hikes, they replaced the term “ongoing” rate hikes with “some additional policy firming may be appropriate.”

Carry on

The Fed reminded us that even amidst an ongoing (albeit appears to be improving) banking crisis, inflation and growth still matter. In our view, the current stress in the banking system will likely reduce future bank lending and therefore, future economic growth. While not desirable on its own, lower economic activity should also reduce inflation.

Clearly, a banking crisis is not the preferred path to lowering inflation, but this episode did show that regulators (and industry leaders) learned many lessons from the Global Financial Crisis. In my view, those lessons made this crisis much less severe, and I would expect we’ll learn a few lessons from this crisis as well. For better or worse, this is the messy, scary, and sometimes painful process of adding resilience to our financial system.

As stability returns to the financial markets, investors will begin to re-focus on the economic cycle. Inflation is still too high, and growth is still surprisingly resilient.

For now, the key takeaways are:

1)There will likely be additional issues with regionalbanks, but the financial system has survived andshown its resilience.

2)Lower credit creation implies lower near-term paths forboth growth and inflation.

3)Long-term investment plans incorporate all types ofeconomic conditions, including this one. The biggestrisk to achieving long-term success is abandoning awell-constructed investment plan at the wrong time.

We encourage investors to look through this period of volatility and maintain discipline to their long-term investment plans.

Key Takeaways

Recent stresses in the banking system, includingepisodes at Silicon Valley Bank, Signature Bank,and Credit Suisse, have put the markets on edge.
The Fed raised interest rates by 0.25%, meetingmarket expectations. They emphasized financialstability while acknowledging that inflation andgrowth have slowed.
Despite a stressful couple of weeks, the financialsystem was resilient. We encourage investors tolook through this period of volatility and maintaindiscipline to their long-term investment plans.

1 While meeting regulatory requirements.

Important Information

AssetMark, Inc. is an investment adviser registered with the U.S. Securities and Exchange Commission.

AssetMark, Inc.

1655 Grant Street10thFloorConcord, CA 94520-2445800-664-5345