If you’ve watched the news recently, you’ve probably heard a discussion of the debt ceiling, in ominous tones no doubt. Congress will need to increase the debt ceiling in order to pass the budget. The deadline is today, September 30th, however, the Treasury can continue to fund the government through October 18th.
If they don’t succeed, the government will shut down and default on its debt.
Congress’ game of chicken over the debt ceiling is nothing new. We were here in 2011, 2013, and 2018; in each case, the issues were eventually resolved.
Will this time be different?
Let’s take a closer look.
National Debt & the Debt Ceiling
The United States is one of the few countries whose laws limit the amount of national debt. This limit is known as the “debt ceiling” – it’s simply the maximum amount of money that the U.S. government is allowed to borrow. Currently, the limit sits at $28.5 trillion.
Carrying a national debt is as American as baseball and apple pie. In fact, we used it to finance our war for independence, so it’s been around for longer than the country itself. The last time the U.S. was debt-free was in 1835. That didn’t last long – just a few years later, a real estate bubble triggered a depression, causing the U.S. to start borrowing again.
We’ve been in the red ever since.
The U.S. borrows money by selling Treasury bonds. Prior to World War I, the Treasury needed specific authorization from Congress before it could issue any new bonds. In 1917, Congress allowed the Treasury to issue bonds at its discretion, so long as the total national debt stayed below the statutory limits they imposed.
It was a way to cut the red tape while keeping a limit on the national debt.
Thus, the debt ceiling was born.
We continually add to our national debt by running a budget deficit; the government consistently spends more money than it brings in. Before the early 1970s, the national budget tended to be fairly balanced. Since then, apart from a budget surplus in the late 1990s, the trend has been to run ever-increasing deficits, intensifying to an extreme after the pandemic.
Where does the government spend? According to the Congressional Budget Office, here are a few highlights from 2020:
As you can see, most of the government’s spending (around 70%) goes toward entitlements and other mandatory expenses. Discretionary expenses make up approximately 25% of spending, while the net interest on our national debt accounts for around 5%.
In 2020, the U.S. had $6.6 trillion in expenditures, but only $3.4 trillion in revenue.
What Happens if the Debt Ceiling Isn’t Raised?
If the debt ceiling isn’t raised, the government shuts down. While most are focusing on the September 30th deadline for Congress to act, the government can continue functioning if the Treasury still has money to spend.
Recently, Janet Yellen, the Secretary of the Treasury, told Congress that the Treasury has enough money to fund the government through October 18th. Given the extreme partisanship in Congress, I would view mid-October as the real deadline.
However, if the debt ceiling isn’t raised and the budget isn’t passed before then, the government would shut down. Some of the consequences would be:
- A suspension of Social Security checks,
- Government workers would go unpaid or be furloughed,
- Veterans’ pensions and benefits would be suspended,
- Food assistance programs would stop, and
- The U.S. could default on its debt.
A U.S. default would be less-than-ideal. In her letter to Congress, Yellen stated that it would “likely precipitate a historic financial crisis that would compound the damage of the continuing public health emergency.” Indeed, we could expect a drop in stock prices, rising interest rates, and a downgrade in U.S. debt should Congress fail to act in time.
Needless to say, should the debt ceiling not be raised, a myriad of bad consequences would result.
What Will Probably Happen
Political theater aside, it’s in the best interests of every politician for this issue to be resolved in time. Mid-term elections are just around the corner – a cessation of entitlements would likely be an unforgivable act in the eyes of many voters.
Along with approval ratings, maintaining low interest rates is another important issue. If investors begin doubting the “full faith and credit” of the U.S. government, then they will begin demanding higher interest rates on Treasury bonds. If this happens, borrowing costs will go up and deficit spending will become more difficult.
Finally, while this may be a cynical take, the debt ceiling issue creates another crisis that allows Congress to fund pet projects and pork spending. For those who depend on Social Security and other entitlements, the debt ceiling debate is more akin to a hostage negotiation scenario. The threat of missing a check can quickly motivate people to get on board with raising the debt ceiling.
If you notice, running a balanced budget or reducing the national debt is never a serious part of the discussion.
I expect the debt ceiling and budget drama to rage beyond the September 30th deadline, only to be resolved sometime in early October before the money actually runs out. The stakes are too high for both political parties to allow the government to go into default. Besides, even the smallest budget proposal on the table would still require the debt ceiling to be raised.
However, investors’ reactions to the political theater will be interesting to watch. Will they demand higher interest rates on U.S. debt? Will they sell off stocks in anticipation of a shutdown? This is the wildcard that can’t be easily predicted here.
If you have questions or worries about the debt ceiling and how it could affect you, then click here to set up a quick, complimentary introduction call to see if Prana Wealth is a good fit. We do still have the capacity to take on new clients.
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