Debt Ceiling: What, Why, and How Bad?
Updated: Jul 27, 2022
[Since this article was written earlier this week, congress has voted to extend the debt ceiling deadline until December. Nonetheless, the context remains the same. Thus, we’ve chosen to publish anyway]
Dear Clients & Friends,
For this Weekend Reading, there were a lot of topics to choose from. Despite eye-popping returns for most clients so far this year, markets certainly stank in September. Supply chain issues remain newsworthy and have become a talking point for everyone. It’s affected everything from iPhones to cat food. In addition, it has fueled inflation - and inflation is obviously something we want to write about.
However, we chose to write about the debt ceiling, because most people don’t really understand it. In addition, most people are not aware of the real risks vs. the “headline” risks of a temporary default of U.S. debt. So, let’s take a brief look at the debt ceiling and what happens if Congress doesn’t come to an agreement on the issues surrounding it. For those of you who do understand this topic, let me warn you that I (we) don’t believe the immediate risk to be nearly as devastating as the mainstream news projects it to be. By “we,” I mean our good friend Brad McMillan, from whom I often borrow content, as he and I see the world in very similar ways. Let’s explore Brad’s take.
To pay for the spending Congress has authorized, the Treasury needs to borrow more money. But it can’t borrow more money because Congress has said that there is a limit, or “ceiling,” to how much it can borrow - and the Treasury has hit that ceiling. So, Congress has essentially forbidden the Treasury to borrow enough money to pay for the things that Congress has said the Treasury has to pay for. If this makes no sense to you, well, I agree. But this is where we are, again. We have seen this movie several times before.
The Treasury hit the debt ceiling several months ago and since then has been using “the usual emergency measures” to pay the bills. Those emergency measures will run out sometime next month, however. At that point, the Treasury will not be able to pay all the bills. Decisions will have to be made over what bills to pay. Social Security? National defense? Bond interest payments? Even more important, decisions will have to be made over what bills not to pay.
Understanding the Crisis
U.S. Treasury debt is universally considered to be a risk-free asset. But if the government doesn’t pay its obligations—if it defaults—then that risk-free status comes into question. As the foundation of the global financial system, any default could shake that whole structure, rattling markets. On a more extended time frame, as the U.S. credit score goes down, the interest rates we pay could go up’s. So, this is a bad thing. While this is definitely a manufactured crisis, it is also potentially a real one.
The thing is, however, that it is not at its core an economic crisis. The U.S. can borrow enough money to pay its bills, and that has never been in question. Instead, it is a political issue. It’s not can we pay the bills, but will we. So far, the answer has been yes, eventually. There are almost always political fireworks around the debt ceiling, like this time, and sometimes the fireworks have turned into a government shutdown.
From a political standpoint, this is and remains a big deal. The overwhelming likelihood is that we will get a deal before the Treasury runs out of money, but that outcome is not certain. So for political drama, watch this space. We could see another governmental shutdown to conserve money, and we could see dramatic headlines about which bills get paid and which don’t. Expect lots of headlines and lots of public drama.
The Economic and Market Impact
Even if we don’t get a deal and do get those headlines, though, from an economic and market standpoint, the impact would likely be limited. There are tools and workarounds to minimize the damage until the politicians reach an agreement. Yes, there would be a pause in payments, but government bills will be paid, eventually, just as they have been in past debt ceiling confrontations.
Since the bills will be paid, the only real economic impact will be in the delay, and that will be small. We have seen this already, as the direct effect of past confrontations and even shutdowns has been negligible over time. The U.S. economy, thank goodness, is much larger than and largely independent of the government.
From a market perspective, we might see more impact, especially in the short term. Volatility is likely. But as with the economy, once a deal is finally reached, that damage will pass fairly quickly. Again, this is what has happened in past confrontations, with short-term volatility fading once a deal has been reached.
A Lot Could Happen . . .
That’s if, in fact, we do not get a deal. But we very likely will. The Democrats may be able to pass a bill raising or suspending the debt ceiling without the Republicans. Some Republicans may join the Democrats to avoid a shutdown or default. There are multiple roads to a successful resolution here. For the moment, then, this is a situation to watch but not to panic about. The risks are real, but certainly not immediate, and even in the absence of a deal not as large as many fear.
I suspect we will be talking about this again in more detail, as we get closer to the drop-dead date—but we are not there yet. As with so many things, lots of things could happen, but most of them will not.
But, I do not think that the U.S. debt will collapse, or that countries will render the U.S. dollar valueless, or that our military will cease to operate and all troops will be sent home (yes, that seems to be a trending fake news narrative on social media). Your water isn’t going to be shut off, and your portfolio will not go to zero on October 18th. On the other hand, volatility that is created by uncertainty is likely to prevail. So, we have to maintain discipline and navigate the storm carefully - but that’s our job. There’s always a storm somewhere, but clients of MORWM have been given the best umbrellas.
So, stay dry and we’ll let you know when the sun is coming out again. We’ll also let you know if we think the Earth is about to implode – but at this juncture, we don’t think that’s likely.
Have a lovely weekend,
- Your diligent MORWM family
Matthew Ramer, AIF®
Principal, Financial Advisor
MOR Wealth Management, LLC
1801 Market Street, Suite 2435
Philadelphia, PA 19103
P: 267.930-8301 | c: 215-694-4784 | f: 267.284.4847 |
601 21st Street, Suite 300
Vero Beach, FL 32960
email@example.com | www.morwm.com
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