Decoding the Debt Ceiling Crisis

The headlines this week have warned that we’re nearing a “debt ceiling crisis.” What does this mean? It’s estimated that on January 19, 2023, the United States will have borrowed as much money as it’s legally allowed to borrow and will be prohibited from borrowing more. Why is this happening? In short, the new Congress has failed to pass a law allowing the Treasury to borrow the money that’s needed to make required payments. The Treasury, therefore, will have to use cash on hand right now, as well as any inflows, to pay the outstanding bills for as long as possible—until the money runs out.

If that sounds like an awkward situation, that’s because it is awkward. It also raises very real economic and market risks, which are being played out in the headlines. Let’s analyze in detail what this all means.

The Current Situation

The U.S. government runs a deficit, meaning it spends more than it brings in. So, it continually borrows more to pay the outstanding bills. The problem is that Congress has put a limit on the total amount the government can borrow, also known as the debt ceiling. Congress needs to raise that limit on a regular basis to account for the approved deficit spending. Raising the debt limit has become a regular political football, which is why we’re having this conversation again now. The new Congress has not raised the limit, so we are reaching the debt ceiling.

Once the debt limit is hit, the Treasury cannot issue any more debt, but it still must keep paying the bills. There are “extraordinary measures,” which have been tested in previous debt-limit confrontations, that would allow this to be done in the short term. These include shifting money among different government accounts to fill the gap until more borrowing is allowed. For example, affording the debt by suspending retirement contributions for government workers, or repurposing other accounts normally used for things like stabilizing the currency. The idea is that this will buy time for Congress to authorize more borrowing. This is where we are now, and where we’ll be for the next couple of months.

The Consequences If Congress Doesn’t Act

At a certain point—tentatively estimated to be around June—the Treasury will run out of money to pay the bills. Among those bills are the salaries for federal workers. So, at some point, the government will largely shut down. Some bills will get paid, but many government obligations will go unpaid.

Why We Should Care

Setting aside the political aspect of the situation, this affects investors for several reasons. First, cutting off government payments will hurt economic growth. Limits on Social Security payments, for example, would severely hurt both economic demand and confidence. While Social Security would likely be the last thing cut, other cuts would also hurt growth and confidence. We saw this in prior shutdowns, and the damage was real.

The bigger problem, however, is if payments to holders of U.S. debt are not made and the Treasury market goes into default. U.S. government debt has always been the ultimate low-risk asset, where default was assumed to be nearly impossible. Adding a default risk would raise interest rates, potentially costing the country billions over time. The economic risk, both immediate and long term, is very high.

Reasons to Stay Calm

We have seen this movie before, and while the ending could be very bad, we’ve resolved the problem every previous time. There are a few ways we could do this before June.

The easiest and most likely course of action is for Congress to cut a deal. At this point, it seems the group of Congresspeople really looking for an extended confrontation is quite small. If that’s true, a deal is very possible, and even likely, as the pressure mounts.

Marianna Goldenberg is located at 1705 Newtown-Langhorne Road, Suite 1, Langhorne, PA 19067 and can be reached at 215-486-8350. Securities and advisory services offered through Commonwealth Financial Network,® Member FINRA/SIPC, a Registered Investment Adviser. Fixed insurance products and services offered through CES Insurance Agency.

 Authored by Brad McMillan, CFA®, CAIA, MAI, managing principal and chief investment officer at Commonwealth Financial Network®.

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