Examining the 2011 Debt Ceiling Crisis' Impact on Gold Prices and Predictions for the Future

The ongoing debate over increasing the U.S. debt ceiling is becoming increasingly political. However, what does this mean for gold?

The volatile situation is often referred to as “political theater” and generally has a limited impact on many assets, including gold. But as the situation becomes more crucial, with the inability of political parties to reach a consensus on raising the country’s credit limit in a timely manner, the possibility of a U.S. debt default becomes a major concern for markets.

As of late January, the U.S. has reached its borrowing limit of $31.4 trillion and the Treasury has taken measures such as suspending investments for certain government accounts to pay bills.

If the debt ceiling is not raised by June, the government could run out of funds, leading to increased urgency in calls from President Biden, Treasury Secretary Yellen, and Fed Chair Powell.

On Monday, 06.02.2023, Treasury Secretary Yellen again urged Congress to raise the U.S. debt ceiling, warning of potential “economic and financial catastrophe” if it is not done.

The next day, Fed Chair Powell stated that the Fed cannot be relied on to safeguard the economy if the debt ceiling is not increased. He also dismissed the idea of a trillion-dollar coin and emphasized that the only solution is for Congress to raise the debt ceiling.
In his State of the Union address, President Biden also appealed to Republicans to come together to raise the debt ceiling, noting that some Republicans were using the economy as leverage unless he agreed to their economic plans.

Recently, Speaker of the House Kevin McCarthy and President Biden met in an effort to resolve the issue, but the standoff continued. Republicans have indicated that they would like to see federal spending cuts in exchange for raising the debt limit.

Analysts are warning that the process of increasing the debt ceiling could be tumultuous. Credit Suisse’s Chief Economist Ray Farris stated that the Freedom Caucus is asking for spending concessions and that this could be the main obstacle. Farris added that a resolution is unlikely to come quickly and that the journey to a higher debt ceiling could be stressful for markets, which have already started to price in default risk.

What happened in 2011 with regards to the debt ceiling?

The previous debt ceiling debate that significantly impacted markets occurred in August 2011, when Republicans and Democrats were unable to reach an agreement and only raised the ceiling just before the deadline.

The result was a negative reaction in risk assets as the U.S. dollar weakened, stocks declined, and credit spreads expanded. Additionally, Standard & Poor’s downgraded the United States’ long-term credit rating from AAA to AA+.

There is a possibility of a similar scenario happening this time as the negotiations to raise the debt ceiling are just starting. As the politicians engage in discussions, analysts anticipate heightened market volatility, especially closer to the June deadline.
JPMorgan stated that the impact of a failure to raise the debt ceiling could be economically disastrous, potentially leading to a global recession, and disruptive for investors, such as persistently higher Treasury borrowing costs. However, if history repeats itself, JPMorgan believes that policymakers will ultimately reach a compromise and the impact will be short-lived.

Gold Analysis
In order to assess the impact on gold, it is useful to examine how gold performed prior to August 2011 and afterward. During August and September 2011, gold rose, surpassing $1,900 per ounce for the first time and reaching its then record high of $1,910 per ounce.
However, when the debt ceiling was eventually resolved, gold reached its peak. The next time that gold was able to surpass $1,900 per ounce was in July 2020.

Gold price graph; Source: Macro Trends

A similar pattern to what happened in 2011 could happen again, where the price of gold would increase leading up to June, but once the debt ceiling is raised, the prices may see a peak for the time being, according to Michael Boutros, senior technical strategist at Forex.com. He explained that if the credit rating is lowered or if there is a close approach to default, gold would be in high demand, but once the resolution is achieved, a quick liquidation in long hands may result in a larger selloff of gold. Boutros stated that the debt ceiling resolution could actually become a near-term high for gold prices.

Sean Lusk, co-director at Walsh Trading, stated that the lessons learned from 2011 could be “buy the rumor, sell the fact.” He pointed out that anytime the supply of something increases while its value decreases, the result would be reflected in the dollar, and given the uncertainties during that time, gold had increased above $1,900 an ounce before it started to decrease. He added that rate cuts and a lower US dollar also contributed to the 2011 rally in gold.

Boutros also noted that from a short-term perspective, gold is expected to see more consolidation before its next big move higher. He indicated that if we consider the parallel to the price action that happened in 2011, it would suggest a few weeks to a couple of months of consolidation before the next move, and that $1,807 needs to hold as support over the next couple of weeks for this to happen.

According to Forex.com senior technical strategist Michael Boutros, a similar situation to what occurred in 2011 might occur again, where gold prices would increase closer to June and then reach a peak after the debt ceiling has been raised. Boutros warned that once the crisis is resolved, there might be a larger selloff in gold, a quick liquidation of those who had long hands. Boutros believes that the resolution of the debt ceiling could serve as a near-term high for the price of gold.

Co-director of Walsh Trading, Sean Lusk, also noted the lessons learned from the 2011 experience, which could be “buy the rumor, sell the fact.” Lusk explained that when the government prints more money that is worth less, it results in a decline in the value of the dollar and this leads to an increase in the price of gold. He also added that the rate cuts and a weaker U.S. dollar also contributed to the 2011 rally in gold.

Boutros stated that from a short-term perspective, gold is expected to see more consolidation before its next big move upward. On the other hand, JPMorgan recommends holding gold during this time as it is one of the assets that could balance U.S. overweights across asset classes, along with other currencies and precious metals like the Japanese yen and the Swiss franc.

Precious metals expert Everett Millman explained that gold is a neutral asset that is not subject to government policy and therefore, it becomes more attractive during times of government spending. Millman added that although the impact of the debt ceiling issue on gold might be temporary, it is still an interesting parallel to what occurred in 2011. He also stated that gold has always been a safe way to store wealth and is a logical alternative to relying on the government to manage the financial system. Millman predicts that this could drive more interest in gold, especially from traders and investors who haven’t been paying attention to precious metals.

In conclusion, the ongoing debate over increasing the U.S. debt ceiling has the potential to have a significant impact on the markets and gold. If the debt ceiling is not raised by June, the possibility of a U.S. debt default becomes a major concern for markets, leading to increased urgency in calls from President Biden, Treasury Secretary Yellen, and Fed Chair Powell. Analysts are warning that the process of increasing the debt ceiling could be tumultuous, causing heightened market volatility, especially closer to the June deadline. The impact of a failure to raise the debt ceiling could be economically disastrous and disruptive for investors. A similar scenario to what happened in August 2011 could happen again, where gold prices would increase closer to June and then reach a peak after the debt ceiling has been raised. According to Forex.com senior technical strategist Michael Boutros, a quick liquidation of those who had long hands could result in a larger selloff in gold, serving as a near-term high for the price of gold. Sean Lusk, co-director at Walsh Trading, stated that the lessons learned from 2011 could be “buy the rumor, sell the fact,” where gold increases due to uncertainties, but decreases once the crisis is resolved.