Political strife is not a new concept and given the current climate there’s no reason to believe that it will abate anytime soon. Though it seems we received a break when President Obama signed a bipartisan budget deal on Oct. 30, it is understandable that the fatigued American constituent is skeptical of how long this latest show of compromise can last. And given that we are within a year of the next Presidential election, many Americans perceive this as a time when enacting policy change in Washington D.C. becomes extremely difficult. However, it is still important to understand certain political concepts like the debt ceiling and federal budgets; for having a grasp on these topics people can better manage what is in their control – their financial picture.
To begin, a brief explanation of the debt ceiling and why it matters is helpful. Every year the government relies primarily on tax revenues in order to fund all of its discretionary and mandatory programs. However, since 1940 there have only been 12 years in which the government received more in revenue than it has spent in outlays.1 In order to fund this shortfall, the government borrows by issuing debt; and as a measure to control spending, Congress created the debt ceiling, or a cap, for how much outstanding debt the federal government can carry. Often though, the government spends more than initially anticipated and as a result they brush up against that debt ceiling. So in order to continue with necessary spending and to make debt payments, Congress typically raises the debt ceiling when needed. This is neither new, nor unusual. Since 1940, the debt ceiling has been altered 95 times and last week’s budget agreement marked the 96th time it has been adjusted.2
This simple yet misguided solution should give us pause. The point of the debt ceiling is to enforce, not casually suggest, a budget in which the government should operate. Should we as individuals employ this mentality, we would soon suffer the unpleasant financial consequences of never-ending debt and an ultimate failure to achieve our goals. Luckily, we have our better judgment and the constraints of the traditional banking system to keep us in line. Unfortunately there are minimal repercussions for Congress given the government’s continued wasteful spending. Last year alone, there was nearly $1.1 billion spent on wasteful projects.3 These kinds of frivolous expenditures leave no doubt that Congress needs to spend more time focusing on ways to reduce spending by eliminating useless programs rather than constantly making adjustments to the debt ceiling. Such actions have not only been a drag from a fiscal perspective, but have also impacted the capital markets.
Recall what happened in July 2011 when the debt ceiling was nearly breached. In the weeks leading up to the deadline, politicians on both sides of the aisle were vying to get concessions from their counterparts. Then, with two days remaining until the U.S. Treasury Department would run out of funds to make interest payments on its debts, a deal was reached and the debt ceiling was raised. Politicians may have breathed a sigh of relief, but the delay in getting a deal done wound up costing the U.S. its AAA credit rating. Citing “political brinkmanship” in the debate over the debt, Standard & Poor’s opined that the U.S. government’s ability to manage its finances had become “less stable, less effective and less predictable.”4 In the days following the U.S. credit downgrade, the S&P 500 sold off nearly 15 percent, inciting the most volatile week in the markets since 2008.5
The reality is that politics can have a direct impact on the markets, but when confronted with such situations, we as investors need to focus on what we can control – our own spending and savings behavior. Until we all have a printing press in each of our homes that would allow us to print money at will, astute short-term and long-term financial planning is still critical in achieving your financial goals.