On January 19th, 2023, the United States Government hit the debt ceiling, which in a nutshell, is the amount of national debt that Congress lets the Treasury Department incur on its balance sheet. Since then, an agreement has yet to be reached. An explanation of this event and the potential impact is outlined in this blog.
The most basic way to think about government debt is in terms of an individual who incurs debt to finance a home, a credit card, or college tuition. In the case of the federal government, the largest categories of spending include income security (unemployment compensation is a primary example), social security, healthcare, national defense, and Medicare, which is a category of itself.
The difference between an individual and the U.S. Government is as follows: governments have an advantage over individuals as they have a revenue stream dictated by law, which is taxes. Unfortunately, the famous quote rings true – death and taxes are the only things certain. We often recognize Ben Franklin’s sympathy towards individuals, but it also points to the unique status of governments.
A reasonable amount of debt in a stable nation can continue indefinitely if the balance sheet is managed properly. The overall amount of debt, while staggering, may not be the best indicator. A better indicator of the debt problem is the amount of debt compared to our Gross Domestic Product, or G.D.P. Since 2013, the debt of the U.S. has exceeded the yearly G.D.P., which crossed a critical milestone of concern.1 What is considered a reasonable amount of U.S. debt is an entire essay unto itself, but be aware, the debt is and remains a growing concern. (No pun intended).
The Debt Ceiling:
Given that the U.S. hit the debt cap in mid-January, what impact has this had? In the immediate aftermath, Secretary Yellen enacted “extraordinary measures”, which prevented a U.S. default and allowed the government to continue paying its bills. The problem is this is a temporary solution, and the debt ceiling will need to be raised in the next several months.
Since 1960, Congress has acted 78 times to raise or modify the debt limit. This has happened 49 times under Republican presidents and 29 times under Democratic presidents.2 The key differences are not necessarily to raise the debt ceiling but rather how the ongoing budget deficit can be controlled and what programs (Medicare and Social Security being at the forefront of most debates) may be adjusted or cut to materially slow the growth in government debt.
While threats of default are often thrown out by some, it would be the equivalent of a nuclear meltdown in economics. The threat by politicians is often brinkmanship and an attempt to force negotiated efforts for specific cuts in expensive government programs.
What to do:
The uncertainty over whether a debt deal gets done, and more importantly when it gets done, can often lead to market volatility. Politics are one of the most difficult areas to handicap, and investors are not necessarily against change. Rather they operate best based on future expectations that can be reasonably predicted.
In many ways, investors anticipate a debt deal will be completed by congress, and markets have responded with a modest rally in 2023. History has proved that the debt ceiling will likely be raised. The best we can do as investors is to manage to your long-term financial goals, not to the interim politics that play out in Washington.