The Debt Ceiling and Congressional Brinkmanship

“I could end the deficit in 5 minutes. You just pass a law that says that anytime there is a deficit of more than 3% of GDP, all sitting members of Congress are ineligible for re-election.” Warren Buffett, Chairman and CEO, Berkshire Hathaway

Around October 18, Treasury Secretary Janet Yellen and the U.S. Treasury Department have warned Congress that the government will no longer be able to pay all its bills unless the $28.5 trillion statutory debt ceiling is increased or suspended.

Source: Congressional Research Service, Congressional Budget Office, and the Treasury Department. Data as of 05/01/2021.

Moreover, Secretary Yellen believes the economy would fall into a recession if Congress fails to address the borrowing limit before an unprecedented default on the U.S. debt.

While the U.S. has never failed to pay its bills, economists say a default would tarnished faith in Washington’s ability to honor its future obligations on time and potentially delay Social Security checks to some 50 million seniors and delay pay to members of the U.S. armed services.

“If you ask the question of Americans, should we pay our bills? One hundred percent would say yes. There’s a significant misunderstanding on the debt ceiling. People think it’s authorizing new spending. The debt ceiling doesn’t authorize new spending; it allows us to pay obligations already incurred.” Peter Welch (D-VT), U.S. House of Representatives Democratic Caucus Chief Deputy Whip

Increases to the debt ceiling aren’t new. They’ve occurred dozens of times over the last century, mostly matter-of-factly, a tacit acknowledgement that the bills in question are for spending that Congress has already approved.

One thing separating today’s debt debate from those of the past is the larger-than-ever national debt, according to Fidelity. Publicly held US debt topped 100% of GDP in 2020 and is expected to reach 102% by the end of 2021.

And the debt is projected to increase significantly in the future. The Congressional Budget Office (CBO) projects a federal budget deficit of $2.3 trillion in 2021—the second largest deficit since 1945.

Source: Congressional Budget Office, as of February 11, 2021.

Failure to address the current challenge could shake global markets even before the Treasury has exhausted its available measures to pay bills. A U.S. debt default, whether through delayed payments on interest owed on U.S. Treasuries or on other obligations, would be unprecedented.

The effect would be one of perception. And, perception can be tied to the reality that someone isn’t going to be paid on time, whether it be government contractors, individuals who receive entitlement payments, or someone else. The damage to U.S. credibility would be irreversible.

Even if a default were only technical—if payments other than interest on debt were delayed—the United States could no longer fully reap the benefits bestowed on the most reliable debtors.

Interest rates would likely rise, as would financing costs for businesses and individuals. Debt ratings would be at risk. The government’s own financing costs, borne by taxpayers, would increase. Stock markets would likely be pressured as higher rates made companies’ future cash flows less predictable. Such developments occurring while economic recovery from the COVID-19 pandemic remains incomplete makes the potential scenario all the more important to avoid.

Let it be said that no one doubts the ability of the United States to pay for its obligations, according to Vanguard. There is a minimal credit risk posed by the United States is supported by its strong economic fundamentals, excellent market access and financing flexibility, favorable long-term prospects, and the dollar’s status as a global reserve currency.

The House has passed a measure that would suspend the debt ceiling through mid-December of 2022, and the bill now goes to the Senate. Republicans in the Senate oppose any effort to raise the borrowing limit and appears intent on making Democrats address it as part of their sprawling investment in social programs and climate policy under reconciliation.

Senate Democrats could lift the debt ceiling without the GOP votes through reconciliation, although that would come with downsides. Under reconciliation, a simple majority of senators can pass a very small number of budget bills each year. The process is sufficiently complex that it would probably take a couple of weeks and distract Democrats from their negotiations over Biden’s “Build Back Bette” agenda.

Thus, the Democrats resist raising the debt ceiling through reconciliation if it means potentially sacrificing other policy goals. And, the rules for reconciliation would require Democrats to specify a new limit for the national debt which would expose them to potentially uncomfortable GOP political attack ads.

Republicans insist that since Democrats control both the executive and the legislative branches and are in a socialistic tax-and-spend binge, they should bear sole responsibility for dealing with the debt limit, which is rearing its ugly head again because the suspension included in a two-year 2019 budget deal expired on July 31.

While top Democrats have argued against using reconciliation to raise the debt limit, their staff has also consulted with the chamber’s nonpartisan parliamentarian to chart out the process for possibly doing so. https://t.co/RDg6bvUtBE

— WSJ Politics (@WSJPolitics) October 4, 2021

Democrats argue that Republicans should share the burden of this unpopular chore, since (a) much of the debt involved was run up under Republican presidents and (b) Democrats accommodated Republicans on debt-limit relief during the Trump presidency.

For long term investors, it’s clearly in the best interest of the country to resolve any debt-ceiling issues, according to Fidelity. And, it’s important to understand that there will always be times of uncertainty. It’s important to take a long-term view of your investments and review them regularly to make sure they line up with your time frame for investing, risk tolerance, and financial situation.

References:

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