If you follow business/financial news at all, it’s likely that you’re aware of the looming debt ceiling crisis.
In this month’s contribution, we want to peel back the onion and provide a clearer understanding of what it’s all about.
Why is the debt ceiling important?
Also known as the statutory debt limit, the debt ceiling is a legal limit set by the United States Congress on the amount of debt that the federal government can accumulate.
When the government spends more money than it takes in through taxes and other revenue, it borrows money to make up the difference. This borrowed money increases the government’s debt.
When the debt reaches the legal limit set by the debt ceiling, the government is unable to borrow any more money until the debt ceiling is raised by Congress.
Implications of Hitting the Ceiling
Consequences could include:
- Government shutdown of certain non-essential operations.
- Default on debt obligations which would likely result in increased volatility (and short-term hit) to the economy and financial markets.
- US credit rating could get downgraded.
- Borrowing could get more expensive.
- Treasury holders of maturing treasuries will be SOL.
History of Debt Ceiling Crises:
This isn’t the first time that political brinksmanship has pushed us towards defaulting on our national debt.
- 1917: Modern concept of the debt ceiling is established.
- 1940s-1950s: Debt ceiling was raised during WWII and the post-war period to finance the war effort + support growth.
- 1970s-Early 2000s: The debt ceiling was raised multiple times with little controversy or public debate.
- 2011: A political dispute over the debt ceiling resulted in the first-ever U.S. credit downgrade and a stock market sell-off.
- 2013: Debt ceiling dispute resulted in 16-day government shutdown.
- 2015/2017/2019: Congress successfully negotiated last-minute compromises that avoided hitting the ceiling.
Different Views on Debt and Deficits:
While there are certainly many different views on sovereign debt and deficit spending, we wanted to share two views from two authors we’ve recently read:
Stephanie Kelton: Author of The Deficit Myth
Stephanie argues that we should not conflate federal debt and personal (i.e. household) debt.
Kelton, a proponent of Modern Monetary Theory (MMT), argues that the government is not like a household in that it does not have to balance its books to avoid default.
Instead, Kelton and other MMT’ers advocate that so long as the federal government has access to real resources (labor/capital), the government can always a) create money and b) pay its debts.
MMT also suggests that the government should be focused on spending to address important social/economic needs and that hyperinflation (i.e. currency depreciation) is a valid, yet ancillary, concern that can be controlled via fiscal discipline.
Kelton and MMT note that as long as a government controls its own currency, it has the ability to use monetary policy to influence the value of its currency.
For example, the government can decrease (or increase) the money supply, which can lead to currency appreciation (or devaluation).
Note that MMT is still a developing theory and its full implications/limitations are still being debated by economists and policymakers.
Ray Dalio: Famed investor and author of Principles for Dealing with the Changing World Order: Why Nations Succeed and Fail
Ray Dalio outlines how poorly managed monetary policy can directly influence the fall of empires.
Dalio, who has conventional macroeconomic views and is supportive of market-based solutions, argues that the management of sovereign debt and deficits is critical for effective governance.
Dalio’s principles are focused on promoting economic growth, fostering innovation, and developing effective governance systems that can:
a) minimize the odds of rampant inflation and
b) manage the complex economic and political challenges of the 21st century.
He argues that large debt and deficits can have significant consequences for the economy and the financial markets, particularly when interest rates are rising.
Dalio’s book also provides historical context for the U.S. dollar – the world’s most recent reserve currency – noting that its dominance can lead policymakers to abuse its position by printing too much money, leading to inflation and (eventually) devaluation of the currency.
Overall, Dalio’s views on the U.S. dollar as the world’s reserve currency reflect a nuanced perspective, recognizing the benefits and risks of the current system and the importance of considering both short- and long-term implications of monetary and fiscal policy decisions.
What you can do:
In short: not much.
If the US defaults on its debt payments, there will be very few places to run or hide within the financial markets.
Geopolitically, this could be another strike (at least symbolically) against the idea of US exceptionalism and increase existing power struggles between the US and China.
Here at wHealth Advisors, we’d like to think that our elected officials understand both game theory + the stakes of the game they’re playing.
Perhaps we give them too much credit.
Either way, we’re rationally optimistic that we’ll avoid devolving into a developing country and that a compromise on the debt ceiling will be reached – one that might result in increasing the debt ceiling, decreasing spending, or some mix of both.