The Debt Ceiling is once again making front-page news, and investors are becoming increasingly anxious over what it means for their personal lives as well as their portfolios. In a nutshell, the JNBA Investment Committee believes the risk of the U.S. government defaulting on its debts is quite low. However, we acknowledge that the consequences of a default are severe enough that this impasse will likely be in the news for months to come. Setting the political drama aside, our goal is to provide a framework for understanding this difficult subject and what possible portfolio adjustments should be made for a low probability event.
What is the Debt Ceiling?
The U.S. maintains an official limit on total federal debt that is independent of spending and borrowing decisions. Essentially, this “debt ceiling” (currently $31.3 trillion) is the limit on how much the U.S. government can borrow. Raising the ceiling lets the government borrow to cover the gap between spending and taxes already approved by Congress. If lawmakers do not vote to raise the limit in coming months, the U.S. government risks defaulting on its debts, which has never occurred before in American history.
Are Politicians Bluffing?
Many politicians who would like to see a combination of tax increases and cuts to entitlement programs are threatening to withhold votes on raising the Debt Ceiling to extract concessions. In our view, this political game of chicken is dangerous, but this political theatre has never caused a default since the law was enacted in 1917. While this doesn’t prove the ceiling will be raised this time, we’d note things turned out mostly fine the last few occasions this game of chicken was played (2013, 2018, 2021). It doesn’t work out perfectly, however, as the U.S. had its debt rating downgraded in 2011 by postponing the final vote to the eleventh hour.
Lawmakers will look to the market for guidance, and markets are likely to get increasingly anxious (i.e., volatile) as time passes. But since it is in no one’s interest to default, we expect legislators to vote to raise the limit. Unfortunately, the U.S. is the only nation in the world with a debt ceiling, and the sheer amount of debt – combined with aging demographics – will make it more challenging to service our obligations in the wake of higher interest rates. According to the Economist, in the fiscal year of 2022-23, America’s Treasury may need to borrow almost twice as much from investors as it did during each of the two years preceding the COVID-19 pandemic and four times the average in the five years before that.
What Can the Treasury Do?
Even though our government has “maxed out its credit card,” the U.S. Treasury currently has enough cash on hand and can slow its burn rate by taking extraordinary measures to buy time until a crisis nears in midsummer. But as markets always look ahead to anticipate the future, the debt ceiling debate is creating price volatility months before the political issue comes to a head sometime between June and August.
What is Different this Time?
A simple majority vote in both houses of Congress would be sufficient to raise the statutory limit on our total debt. However, the new Speaker of the House recently allowed three Freedom Caucus members to sit on the Rules Committee, and they are demanding spending cuts for raising the debt ceiling even though they do not have the support of a majority of House Republicans. Here’s the rub – any legislation placed on the floor must proceed through the Rules Committee, which means these legislators can effectively halt any must-pass legislation.
What Would a Default Look Like?
A failure to raise the debt ceiling does not override any legal obligation to spend; the debt ceiling is written into law, but so are Social Security, Medicare, Medicaid, and interest payments. Regardless of the Debt Ceiling, the U.S. government cannot legally default on any obligation. But if the government cannot borrow, it must impose large and painful reductions in spending. While our U.S. Treasury is contemplating the need to delay payment on some of its bills, most private entities will likely carry on with business as usual, knowing that any impasse would be short-lived. Still, our unwillingness to pay our bills could rattle financial markets and raise doubts about our creditworthiness, which could reduce the confidence of lenders and result in both a spike in interest rates or a falling U.S. dollar as our lenders would begin to question the full faith and credit of the U.S. government.
Should I Worry and What Should I do?
Political posturing will likely result in greater volatility in financial markets. If you have any upcoming larger cash needs that you have not already communicated to your JNBA Advisory Team, it is always best to communicate those in advance of needing the funds in an effort to try and avoid selling securities in a market downturn. You may also want to reconsider that trip to The Grand Canyon, as national parks are likely to close as extraordinary accounting measures are implemented by the U.S. Treasury to preserve cash.
From a portfolio perspective, it is situations like this that further support the value of a well-diversified portfolio that includes some assets outside of the financial system that would benefit from a weakening U.S. dollar – such as real estate or gold. The most important thing investors can do is steel themselves to be cool-headed in the face of potential rising volatility in the months ahead that will likely be resolved with some incremental budgetary discipline. The JNBA Investment Committee will continue to monitor progress on Debt Ceiling negotiations closely. If you have any questions about your portfolio, or have fresh updates on your cash flow situation, please do not hesitate to reach out to your JNBA Advisory Team.
Due to various factors, including changing market conditions and/or applicable laws, the content may no longer be reflective of current opinions or positions. Moreover, you should not assume that any discussion or information contained in this blog serves as the receipt of, or as a substitute for, personalized investment advice from JNBA Financial Advisors, LLC.
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