The Debt Ceiling Debate

| June 5, 2023 | 0 Comments

There are a LOT of things I would rather be discussing right now, but because Washington is what it is, the raising of the national debt limit is back on the front pages as the hot topic du jour. If this sounds familiar, it’s because it is. So, here’s a little background on why we have to endure this maelstrom yet again.

Spoiler alert: In all likelihood, the debt limit will be raised, the government will NOT default on its obligations, and investors will move on to whatever the next headline crisis is. My advice: don’t click on the scary headlines and don’t believe half of what you read or see, especially in partisan media like Fox or MSNBC.  

What is the debt ceiling (or debt limit)? It is a cap on the amount of debt that the US Treasury is allowed to borrow. Because the US government normally spends more than it receives in revenues, the national debt is growing, and we keep hitting the limit.

Why do we have a debt ceiling? Before World War I, Congress had to authorize every single auction of Treasury securities to fund spending. In order to expedite funding of the war, Congress passed a debt ceiling and basically gave the Treasury department the green light to do whatever was needed.

Why are we debating this at all? For most of the last century, the debt ceiling was a non-issue, raised more or less by consent in order to allow Treasury to continue to fund the spending approved by Congress. There was even a rule in effect for a while that raised the debt limit whenever Congress authorized spending more money than they received in revenues. It’s only fairly recently that the debt limit has become a political football and an opportunity for politicians to grandstand about spending.

If Congress authorized the spending, shouldn’t the debt limit be raised with it? That would make the most sense, but holding the debt limit hostage is a powerful tool for the opposition party (in this case, Republicans) to exact concessions from the other side. The debt limit has been raised seven times in the last twelve years, often with little drama.

What happens if the debt limit isn’t increased? Politicians debate this, but most analysts do not. Because the government is spending more than it’s taking in, a failure to raise the debt limit would mean that the government could not pay all of its bills. In a worst-case scenario, millions of government workers and contractors would be laid off or furloughed. It’s unlikely that things like debt or Social Security payments would be delayed, but given the variable timing of cash receipts, this can’t be ruled out. If the government shut down for a couple of weeks, that’s not the end of the world, but it would be very disruptive. If it lasted longer, creating several million unemployed workers would not be good for the economy. Even the suggestion that the US government couldn’t meet its obligations would be devastating to our global reputation and leadership, and would likely lead to higher interest rates across the board for US corporate, government and individual borrowers because almost all interest rates are based on US Treasury bond yields.

Why hasn’t the stock market reacted if the result of a default would be so severe? In part, this is because we’ve seen this play out several times in the past twelve years. In 2011, when the debt limit was raised within hours of defaulting, the investors did freak out and losses in stocks were huge, but markets recovered relatively quickly. Expect more volatility as the “X-date,” (the date the government truly runs out of cash) comes closer without a resolution, but most analysts who follow politics in Washington expect that this will be resolved before a default happens.

The bottom line is that for investors, this squabble is most likely to be a nothingburger. There will be lots of headlines, scary news stories, and breathless analysis about the coming catastrophe. After all, crisis sells papers and advertising. But at the end of the day, the consequences of default are unimaginable, and nobody wants to really see what would happen.

As long as you have emergency reserves in your savings or checking account, you can focus on the long-term and ignore these tea-pot tempests.

This column is prepared by Rick Brooks, CFA®, CFP®. Brooks is director/investment management with Blankinship & Foster, LLC, a wealth advisory firm specializing in financial planning and investment management for people preparing for retirement. Brooks can be reached at (858) 755-5166, or by email at Brooks and his family live in Mission Hills.

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Category: Finances, Government, Local News, National News

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