If the U.S. Congress is unable to come to an agreement on budgetary items and raise the debt ceiling by June, the U.S. government could default on its debt, leading to a global financial crisis. So how did our elected officials on the Hill allow us to get to this point? What needs to be accomplished? What are the possible ramifications you should consider?
Taking a step back, U.S. debt is utilized by the government to meet its existing obligations such as Social Security and Medicare benefits, interest payments on national debt, military salaries, tax refunds, and so forth. To be clear, raising the debt ceiling doesn’t authorize new spending or increase federal spending beyond what Congress has already approved. Raising the debt ceiling just allows the government to pay for the obligations it has already made.
The debt ceiling is the legal limit of Treasury debt that the U.S. government can issue, via Treasury bonds and bills, to make payments on the expenditures approved by Congress. In the annual budgeting process for 2023, Congress authorized an annual expenditure budget that exceeded the anticipated revenues (i.e. taxes) collected. It was planned all along that gap was to be closed through the issuance of government debt instruments.
Periodically, the maximum level of debt issued must be approved or raised. Since 1960, Congress voted 78 times to raise the debt ceiling. Republican presidents presided over 49 of these votes, and Democratic presidents over 29.[i] In other words, historically Congress has always acted when called upon to raise the debt limit, under various political leadership, and the event was typically a formality without negotiation. However, this time, politicians are delaying the operational process of releasing the funds (via the debt ceiling increase) to pay for the budgetary items that they themselves have already approved.
Why would anyone do this, you might wonder? Some Republican leaders, are leveraging their voting power on the debt ceiling to negotiate Republican-proposed spending cuts. In other words, politicians are holding the nation and its financial stability hostage to resolve (or get stronger positioning) on a separate future budgetary agenda. So far, some of the spending cuts proposed include reductions in federal health care benefits, blockage of the proposed student-debt cancellation, and a repeal of various green energy initiatives.
The current U.S. debt limit is approximately $31 trillion, approved by Congress in December 2021.[ii] As of January 2023, the U.S. reached the debt limit, and extraordinary measures were enacted by Treasury Secretary, Janet Yellen, to prevent the U.S. from defaulting on its obligations until Congress can agree on increasing the debt limit. However, those extraordinary measures are anticipated to be insufficient to make good on the U.S. debt after early-June, or what people have labeled the “x-date.”
The United States has never defaulted on its obligations, so the full reach of negative repercussions are unknown. However, Yellen warned House Speaker Kevin McCarthy that waiting until the last minute to increase the debt limit could harm business, diminish consumer confidence, raise short-term borrowing costs, and negatively impact the credit rating of our nation. Outright failure to raise the debt limit could cause severe hardship to American families, harm our global leadership position, and raise questions about our ability to defend our national security interests.[iii]
In daily life, failure to raise the debt ceiling could become visible as the U.S. Treasury Department reduces payments to government employee retirement plans, interest and principal payments to government bondholders, Social Security payments, Medicare reimbursements, payments to federal contractors, and salaries of federal employees. Further, we could see national parks close and air travel disruptions, given air traffic controllers are government employees.
The worse possible outcome would be if the U.S. government is unable to make payments on government bonds, which would be considered a default on our sovereign debt. Such an occurrence could lead to instability in the global financial system, as the U.S. dollar is the world’s reserve currency. For example, prior to Russia invading Ukraine, nearly all of the oil purchased globally was bought with U.S. dollars. If there is a shortage or uncertainty surrounding the dollar, countries may start to look for another reserve currency. Domestically, the stock markets might tumble (albeit likely temporary), there could be a selloff of government bonds, interest rates might surge, and the U.S. would likely go into a recession.[iv]
So what needs to be accomplished? Congress needs to pass the debt ceiling and make good on the payments it has already committed to making. If politicians really want to make change, they should focus on the actual budget and try to align incoming tax revenues with government expenditures. Correct framing is important also. As the world’s reserve currency, the U.S. has to issue bonds because that ultimately provides the global marketplace with a readily available currency to allow countries with different currencies to do business together.
In the near future, you should expect a great deal of unnecessary market volatility caused by a manufactured government crisis. Volatility could extend to all facets of the market, stocks, bonds, alternatives, and even cash, as banks struggle. Scary news headlines reflecting upon the losses of prior recessions will drive fear-induced trading and some short-term panic. However, rationality should remind us that Congress cannot delay an agreement forever. Sooner or later, both sides of the aisle will forge a path ahead. Investors should use this opportunity to examine their investment portfolios. Ensure you are not exposed to more risk than necessary. It’s been said that stocks can build wealth, but diversification keeps you wealthy. In times of volatility, a well-diversified portfolio of balanced assets classes can be one of the best ways to reduce short-term losses and allow you to capture market recovery on the other side. Investors who jump in and out of the stock market have to be right twice. You need to know when to get out, and if you’re hearing it on the news, you’re already too late. Then you need to know when to get back in, and that’s typically the harder of the two maneuvers. Often, when jittery market timers finally feel confident enough to buy, they’ve already missed some of the best trading days of the entire year. That’s because stock market recovery comes swift and strong. Reach out to your Certified Financial Planner™ for reassurance or a second opinion if you’re feeling uncertain. Also, remember to work with a fiduciary, who is committed to putting your interests and well-being first, without bias.
[iv] Bob Veres, Inside Information