Tax the Rich or Cut the Debt

A showdown is brewing between Biden and Democrats with control of the US Senate and Republicans who control the House of Representatives. In simple terms the Democrats want to “tax the rich” in order to balance their new budget while the Republicans want budget cuts across the board to cut the debt this year and going into the future. The specifics include a proposed $6.9 trillion budget, $5.5 trillion in increased taxes over a decade versus $150 billion in budget cuts this year instead of a $77 billion increase. Tax the rich or cut the debt will be the rallying cries as options traders choose profitable strategies for a volatile market.

Potential US Debt Default

The United States has been out of money for about a month now as Congress has not increased the debt ceiling. By moving money around and delaying payments when able, US Treasury Secretary Yellen will be able to avoid an outright debt default for about two more months. The general consensus is that a default on US debt payments would lead to financial catastrophe in the near term and long term ripple effects on the value of the dollar and the position of the dollar as the international currency. Because the Republicans have taken back the House of Representatives but no longer hold the Senate or the White House their only recourse is to threaten a default in order to get the budget cuts that they want without increasing taxes.

Tax and Spend Versus Where to Spread the Pain

The last years when the US had a budget excess were at the end of the Clinton years and before that it was in the 1960s. Both parties have been responsible for spending increases and tax cuts that have brought the US to the point of having a $31 trillion debt as interest rates go up making debt servicing increasingly expensive. Items in the budget are always argued on their individual merits without comparing to other items. Of course the proponents of any individual line item routinely argue that the republic will fall in ruins if their items are not funded.

Over the years various suggestions have been made such as simply cutting every line item by 1% a year until the budget was balanced or introducing “sunset” clauses that require legislation to be revisited and passed again or it will expire. Congress passed the first debt ceiling legislation in 1939 and has routinely increased that ceiling over the years. In recent years it has virtually always come down to the wire before a deal is reached but has always been increased. The problem is that at some point the game of “chicken” will result in an actual default where the Treasury cannot issue checks to cover US debts.

How Will the Market React?

The first thing to remember is that for years now, the budget submitted to Congress by the President is a bargaining chip and most of the details are dead on arrival. Likewise, statements by the Speaker of the House of Representatives need to be taken with a grain of salt. However, as the debt limit showdown comes down to the wire the market may well get spooked or it may not. As we commonly note, the market only cares when it cares and then it can care excessively and drive prices down dramatically. The debt limit is the first issue that will drive prices crazy.

The next issues will come out of what sort of deal is made to move past the debt limit crisis. Biden wants to bring critical industries back to the USA and many in Congress do as well. Legislation like the infrastructure bill will have support and tend to drive budget deficits. Legislation like child tax credits to bring families out of poverty will probably need help to survive. The biggest issues will be Social Security, Medicare, and military spending.

As the war in Ukraine drags on and images of bombed cities and dead civilians will become old news and support may wane. On the other hand, every time China threatens Taiwan the military gets more support. Most of the support for cutting budgets is coming from Red States which also have the highest proportion of people dependent on Social Security and Medicare which will pose a problem for Republicans pushing to sunset these programs.

Options Trading When Congress Is Fighting

The beauty of options trading is that no matter what is going on in politics or the economy there can be a profitable options trading strategy. At Top Gun Options we watch technical indicators of the market as well as the fundamentals that eventually determine prices. We always hedge our trades and potentially print money in all markets no matter how the fight between Biden and the Republicans works out.