Let’s Talk About The Debt Ceiling
THOUGHTS ON THE DEBT CEILING TALK
It’s hard to not see or hear a scary story about the debt ceiling lately. Remember, the US can literally print our own currency. This is why any comparison of the US government to a household budget is based in ignorance.
I understand the politicians do this to make themselves look important, but all this political theater is just another unnecessary “crisis” to put us all through, i.e., speculating about micro details of the debt ceiling, negotiating tactics, who’s to blame, and the final resolution.
Everyone in DC is incentivized to get a deal done but you never know with these things.
The US has enough revenue to pay all bondholders. The roughly $1.5 trillion deficit this year means that, if the debt ceiling isn’t lifted, we won’t be able to pay all our obligations.
We’ve been here before, having already raised this limit 89 times since 1959. I think it’s very unlikely that any payments on entitlements will get delayed. I believe that an agreement will be reached and that all bond payments will be made on time. In other words, there seems to be lots of smoke and very little fire.
All of this is important because federal spending is largely dominated by entitlements. According to the Congressional Budget Office, this year Social Security, Medicare, Medicaid, and other health-related entitlement programs will cost the federal government 10.8% of GDP. Thirty years from now, it’s projected that these same programs will cost 14.9% of GDP.
Tax revenue is scheduled to be higher, too, due to the expiration of some of the tax cuts enacted in 2017, as well as “bracket creep” (incomes tend to rise faster than inflation, resulting in a larger share of income getting taxed at higher marginal tax rates). But this gain in revenue remains well below the expected increase in spending.
Technically, the government hit the debt limit in January, but it’s been using “extraordinary” measures to keep things going. Secretary Yellen said that due to the volatile nature of tax payments, it’s hard to determine a precise date when we’ll run out of money.
Here’s a little debt ceiling history from Morningstar for reference…
What Is the Debt Ceiling?
The debt ceiling is the legislative cap on the amount of national debt the US Treasury can incur which limits the risk of a public debt crisis. The debt ceiling is a figure—currently $31.4 trillion—that needs to be continually revised as the economy grows.
To meet its obligations (which include paying military salaries, retirement benefits, and interest on the national debt), the Treasury regularly sells bonds (that is, issues new debt) to investors across the globe. Because the US government generally runs budget deficits (meaning it spends more than it collects in tax revenue), the debt ceiling needs to be periodically raised to accommodate additional borrowing. So, the national debt rises.
What Happens After We Hit the Debt Ceiling?
When the amount of debt outstanding hits the debt limit, you might think it would quickly produce a hard deadline to act upon.
This is where “extraordinary measures” come into play. If Congress fails to lift the debt limit, the Treasury could utilize these measures to temporarily keep the government under the borrowing limit, primarily by halting investments in select government funds. This creates headroom under the debt cap, permitting the Treasury to borrow more from the public.
The outcome can’t be predicted, but it would likely create more volatility in financial markets. While that prospect may seem concerning, it also seems unlikely, since, as mentioned, both political parties have previously lifted the limit.
What Happens if the Government Defaults?
If Congress does not suspend or raise the debt limit, the Treasury would likely prioritize paying its obligations while curbing discretionary expenditures.
$31 Trillion National Debt in Context
There’s been an explosion in federal debt; it was $15 trillion in 2011.Today, it’s approximately $31 trillion.
One way to look at the overall level of debt is to measure the interest the US government pays on debt, as a percentage of gross domestic product.
Interest payments on debt are much lower today than in the 1980s or 1990s. Even though the size of our debt has risen substantially, we can still afford to pay it. While the amount of debt was lower in the ‘80s and ‘90s, rates were higher then and the economy was smaller as well. In 2011, the US GDP was $15 trillion. Today, it’s more than $26 trillion…
The simplest observation would be that the federal debt grows as the economy grows, but ultimately the entire pie expands.
Does the debt ceiling matter for portfolio decisions?
The answer depends on your time horizon.
If you’re looking at just the next six months, this fluctuation could be a swing factor in the market’s direction between now and year-end. If your time frame is multiyear, you can take comfort in knowing that instances in which the US approached its debt ceiling are today just footnotes in market history.
Focus only on what you can control. You have no control over politics, tax policy, the economy, or the sequence of market returns. But you can set your goals, maintain your asset allocation strategy, and work to keep your emotions about investing in check.
To be a successful long-term investor, you must be patient. And that means that, periodically, you have to be prepared to outlast some market-related suffering. To survive, you have to tune out the noise and look away from the madness of financial headlines. But you making the right boring decisions can make a world of positive difference in your results in the long run.
Even if the economy did slip into recession, keep in mind that many metrics are at historically strong levels. In other words, a recession could mean the economy goes from being very strong to just slightly less very strong, with limited risk of the bottom falling out thanks to what continues to be a lot of excess demand in the economy, i.e., a “soft” landing.
Bank of America strategist Savita Subramanian has recently hiked her year-end target for the S&P 500 to 4,300 from 4,000, saying that the focus of companies on efficiency would make earnings more stable and that stocks were not overvalued.
“Current valuations are not low, but rarely are low during profit recessions. On cyclically adjusted earnings, valuations argue for price returns of 5% per year for the S&P 500 over the next decade,” Subramanian said in a note to clients. “For the bear case, talk to the person next to you. Geopolitics, Fed error, debt ceiling, financial crisis II, recession, ‘rich-cession,’ credit, stagflation, [commercial real estate], urban demise, civil unrest, rate cliffs, jobs etc., with stock v. bond allocations having dropped to 2009 lows.“
For now, don’t be worried about the debt ceiling debate. The stock market doesn’t seem to be worried – and I don’t believe you should be either. Another explanation is that the market well understands that all of this talk is mostly for show.
Seems to me that if we really were in trouble, the market would definitely be telling us.
Please contact me with any questions or comments.
Michael J. Maehl, BFA™, CRC®, CAS, CES, CTS, CWM
Senior Vice President
Retirement Income Specialist
Office: 509.944.1790
14 E. Mission, Suite 4
Spokane, WA 99202
Email: [email protected]
Website: www.opus111group.com
Michael Maehl uses the trade name/DBA, Opus 111 Group. All securities & advisory services are offered through Commonwealth Financial Network©, Member FINRA/SIPC, a Registered Investment Adviser. Fixed insurance products and services are separate from and not offered through Commonwealth Financial Network.
