Statutory Debt Ceiling
The debt ceiling, also known as the statutory debt limit, is the maximum amount of debt that the federal government is authorized to borrow. The debt ceiling has been a contentious issue in recent years, with some lawmakers advocating for an increase in the debt ceiling to allow the government to continue borrowing and others arguing for spending cuts to reduce the debt. You will definitely see headline news on this issue as members of the Republican and Democratic parties go back and forth, leveraging debt repayments and proposed spending cuts, prior to the August debt ceiling deadline.
The debt ceiling deadline is a date set by congress and the treasury department, when the Treasury is expected to run out of "extraordinary measures" that allow it to borrow beyond the debt limit. The last debt ceiling increase happened on December 27th, 2019 and the next one is expected by August 2nd, 2023, if the Congress doesn't act before that.
It's important to note that not raising the debt ceiling does not mean the government will stop spending, it would have to choose between defaulting on its debt or not paying bills like Social Security, Medicare, and military salaries. It's the debate about which of these line items are 'most dire' that the parties will weaponize against one another in an attempt to advocate or derail each others 2024 General Election aspirations.
While the consequences are high, if a default were to occur, the risk of such is historically extremely low.
Default on debt payments: The government would not be able to make interest and principal payments on its debt, which could lead to a default on its debt. This could have significant negative consequences for the economy and financial markets.
Reduced government spending: The government would have to make difficult choices about which bills and obligations to pay, leading to reduced spending on programs such as Social Security, Medicare, and military salaries. This could have a negative impact on millions of Americans and the economy as a whole.
Financial market disruption: Failure to raise the debt limit and potential default on government debt could lead to a loss of confidence in the government's ability to manage its finances, which could lead to a disruption in financial markets and a decline in the value of the US dollar.
Economic recession: The combination of reduced government spending and financial market disruption could lead to an economic recession, with potentially severe consequences for unemployment, GDP, and overall economic activity.
The US government has had to raise the debt ceiling many times in the past to avoid default and other negative consequences. The debt ceiling has been raised over 100 times since it was first established in 1917. The frequency of debt ceiling increases has increased in recent years, with the government having to raise the debt ceiling several times in the last decade alone; hence why we say the risk is extremely low.
Today the US Federal Government hit the last proposed limit on the debt ceiling and was forced to take extraordinary measures to meet payments until the ceiling can be lifted...in other words the clock is ticking.
Some examples of extraordinary measures that the government can take include:
Suspending the issuance of State and Local Government Series (SLGS) Treasury bonds, which are used by state and local governments to invest proceeds from bond sales.
Suspending the issuance of new debt for the Civil Service Retirement and Disability Fund and the Military Retirement Fund.
Redeeming existing Treasury bonds held by government trust funds, such as the Exchange Stabilization Fund and the Strategic Petroleum Reserve.
Deferring investments in the Federal Employees’ Retirement System's Civil Service Retirement and Disability Fund.
Reducing the balance of the Exchange Stabilization Fund
It's worth noting that these measures are not a permanent solution and they can only be used for a limited time, the estimate of time remaining until these would no longer function is around August 2nd.
What is means for investments?
While the consequences may seem more dire than other market moving issues, we would still say the same reassuring statements: "Don't change your investment strategy based on how you temporarily feel" and focus on your long term goals and holdings that compliment those." Timing the market forces you to not just make the decision on when to exit, but brings into play the even tougher decision on when to get back in. Even professional investors with decades of experience and access to vast amounts of information, struggle to time the market. Studies have shown that even the most skilled investors have difficulty outperforming the market utilizing these tactics. Risk management is our focus and should be yours. Carefully crafting a portfolio designed in tandem with your age and tolerance for volatility will help you withstand the risks of today, tomorrow, and the future. Don't let the debt ceiling derail your investment strategy.