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Should I Worry About the Debt Ceiling?

Should I Worry About the Debt Ceiling?

May 08, 2023

Once again, the debt ceiling is in the news and is a cause for concern. If the debt ceiling binds, and the U.S. Treasury does not have the ability to pay its obligations, the negative economic effects would quickly mount and risk triggering a deep recession.

What’s The Difference Between The Debt Ceiling and Budget Appropriations?

The federal budget sets the amount of money we will spend on all the thing government does. This process is called appropriations. So, this is where we decide what to pay for and how much we plan to pay.

The debt ceiling is the total amount of U.S. Treasury debt. It was created during World War I to regulate U.S. government spending. Since 1959, the debt ceiling has been raised 89 times. The debt limit caps the total amount of allowable outstanding U.S. federal debt.

 Debt ceiling

The U.S. hit that limit—$31.4 trillion—on January 19, 2023, but the Department of the Treasury has been undertaking a set of “extraordinary measures” so that the debt limit does not yet bind. The Treasury estimates that those measures will be sufficient through at least early June. Sometime after that, unless Congress raises or suspends the debt limit, the federal government will lack the cash to pay all its obligations.

Remember that the Federal budget authorized the obligations of the Treasury and those obligations were approved by Congress.

Economists Len Burman and Bill Gale wrote, “Raising the debt limit is not about new spending; it is about paying for previous choices policymakers legislated.”

If the debt ceiling binds, and the U.S. Treasury does not have the ability to pay its obligations, the negative economic effects would quickly mount and risk triggering a deep recession.

The economic effects of such an unprecedented event would surely be negative. However, there is an enormous amount of uncertainty surrounding the damage the U.S. economy will incur if the U.S. government is unable to pay all its bills—it depends on how long the situation lasts, how it is managed, and the extent to which investors alter their views about the safety of U.S. Treasuries. The longer it lasts, the worse things get.

The timing of when Treasury will not have enough cash to meet its obligations—the so-called “X-date”—is uncertain because it depends on the inflows of federal tax payments. Estimates of the X-date range from early June to early fall; the range is so wide because the delay in the tax filing deadline for those affected by storms in California makes the pace and amounts of federal tax particularly uncertain this year. That uncertainty underlines the urgency around this issue. Policymakers may not have as much time as they think to deal with this.

What will Treasury Do When the Limit is Hit?

One cannot predict how Treasury will operate when the debt limit binds, given that this would be unprecedented. Treasury did have a contingency plan in place in 2011 when the country faced a similar situation, and it seems likely that Treasury would follow the contours of that plan if the debt limit were to bind this year. In 2011, the Treasury did not default on Treasury securities. Treasury continued to pay interest on those Treasury securities as it came due. And, as securities matured, Treasury paid the principal by auctioning new securities for the same amount (and thus not increasing the overall stock of debt held by the public).

The plan calls for Treasury to delay payments for all other obligations until it has at least enough cash to pay a full day’s obligations. In other words, it will delay payments to agencies, contractors, Social Security beneficiaries, and Medicare providers rather than attempting to pick and choose which payments to make that are due on a given day.

Federal employees would likely continue working during a debt-limit impasse in contrast to the government shutdowns that occur when Congress hasn’t enacted appropriations bills. That’s because federal agencies would still have legal authority, provided by Congress, to obligate funds. Thus, national parks and other government agencies would likely remain open, but federal workers’ paychecks would be delayed.

Timely payments of interest and principal of Treasury securities alongside delays in other federal obligations would likely result in swift legal challenges. The Treasury wants to keep paying on Treasury securities to protect the U.S. credit rating, but it’s likely that some folks owed payments would sue if their payments were delayed.

The Platinum Bullet

You may have heard of a creative solution that some suggest is possible, “the platinum bullet.” This scenario would have the Treasury mint and issue a “collectible” trillion-dollar platinum coin and deposit it at the Federal Reserve in exchange for cash to pay the government’s bills.

However, Treasury Secretary Janet Yellen has noted that the Fed, reluctant to intervene in a partisan political dispute, might not accept the deposit.

Partial Payments

If the debt limit binds, and Treasury were to make interest payments, then other outlays will have to be cut in an average month by about 25%. That is because the Congressional Budget Office calculates that 25 cents of every dollar of non-interest outlays will be financed by borrowing in 2023. And if the debt limit binds, Treasury can’t borrow, so we are short by 25%. If Treasury were to add Social Security payments to the list of “must pay” obligations then the remaining bills, to vendors, businesses, and other government agencies, would need to be cut by closer to a third.

However, the size of the cuts would vary from month to month because infusions of cash to Treasury from tax revenues vary greatly by month. The uncertainty would add to the chaos and hurt markets further.

Mr. Market is Emotional

Much movement in investment markets is governed more by emotion than by reason. If the government stops paying Social Security, what will stock and bond markets do? It doesn’t look good.

Would investors lose confidence in U.S. Treasury securities? If nobody wanted to buy them, the price would fall and further amplify the shortfall as the Treasury Department sells more securities.

The debt ceiling is clearly out of our control. So, we don’t have to do anything to fix it. If we are careful to always have enough cash at hand to meet needs over the next 6 months or so, we will have time to react if things turn negative. If they do turn negative, it will likely be for a short time.

A sensible, long-term plan is designed to ride through temporary negative periods in the markets. Of course, your situation is unique. So, if you want to talk in specifics about your financial plan and the impact of the debt ceiling showdown, I would be honored to visit with you. As a fiduciary financial planner, I’m always an advocate for my clients. I love talking with new people. Reach out and we can have a get-acquainted visit. Just follow this LINK to find a time that works for you.

Yes, I am a CERTIFIED FINANCIAL PLANNER™ professional. I’m always a fiduciary and I work on a fee basis. And yes, I’m still taking about 6 new families this year to be part of my financial planning practice.

If this article has you thinking about your own circumstances, contact my office at rdunn@dunncreekadvisors.com. I am always happy to meet with people who are working on their retirement plans. Dunncreek Advisors does not provide legal or tax advice, nor is this article intended to do so.