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Debt Ceilings and the Growing National Debt

 

There have been many articles and hours of news television spent on covering the debt ceiling and growing national debt in America.  This recent article and show by Peter Lazaroff does a great job outlining what is being considered in Washington and what it could mean for investors.

 

One of the big news stories for markets recently has been when and how Congress would agree on an extension or suspension of the nation’s debt ceiling. Fortunately, a short-term agreement was reached on October 7, 2021 that raises the US borrowing limit into December and temporarily avoids a situation where our country defaults on its debt. But, the agreement is such that we can expect another show down in just a few months.

 

In today’s episode, I want to explain the history and purpose of the debt ceiling while also taking a look at the country’s overall debt burden and what that means for investors.

 

The debt ceiling was instituted in 1917 to provide more flexibility to finance the United States’ involvement in World War I. Prior to the debt ceiling, Congress directly authorized each individual debt issued.

 

Can you imagine if today’s Congress had to approve every single Treasury bond issuance? Treasury securities are offered multiple times a week, so naturally, it would be a nightmare to keep our government-funded.

 

The Second Liberty Bond Act of 1917 removed the need for the individual approval of each bond issued, but it also introduced limits to the total amount of money the United States government could borrow to meet its existing legal obligations.

 

The debt ceiling is the total amount of money that the United States government is authorized to borrow to meet its existing legal obligations. 

 

Those obligations include paying interest on the national debt, Social Security and Medicare benefits, military salaries, tax refunds, and other payments for the continuation of public good and services.

 

The debt ceiling is different than the budget, which Congress passes every year.

 

The budget includes spending on these items I’ve just mentioned as well as many others.

 

Congress also taxes people to pay for all that spending. In years where government spends more than it takes in from taxes and other revenue, it increases the federal deficit, so the government needs to borrow money to continue paying out what Congress has already OK’d.  The debt ceiling does not have anything to do with authorizing new spending commitments – that’s the budget. The debt limit simply allows the government to finance legal obligations that Congresses and presidents of both parties have made in the past.

 

Two Bills Congress Is Considering

 

 

Today, there are currently two massive bills Congress is considering.

 

  • A bipartisan infrastructure package that includes more than $1 trillion in spending on roads, bridges, rail, public transit, the electrical grid, broadband expansion and more — this has been approved by the Senate and is poised for approval in the House.
  • The second is a more complicated $3.5 trillion bill that focuses on expanding Medicare, addressing climate change, and boosting social programs. That bill, which includes both corporate and individual tax increases, will likely have to be significantly downsized to win the support of moderates in the Senate.

 

These spending bills are separate from the debt ceiling, but the debt ceiling has recently been getting tangled in the negotiations because it’s a source of leverage – and even the tiniest shred of uncertainty about the country paying its legal obligations has seemingly contributed to the recent market volatility.

 

What Does the Debt Ceiling Situation Mean For Investors?

 

 

The debt situation means near-term volatility should be expected, and because it’s expected, there’s no reason to panic. We can’t reasonably predict how this all plays out, nor can we predict how the overall market will react to the outcomes.

 

Thinking back to the 2011 standoff where it was starting to look like Congress wouldn’t reach an agreement, the S&P 500 dropped nearly 20% and (if I remember correctly) the rebound started right when S&P downgraded our debt – the type of headline you might look at and think things are really about to get out of control.

 

The 2011 debt ceiling standoff is a great example of the difficulty in not only predicting the outcome of future events, but also in predicting how the market reacts to those outcomes. With debt ceiling debates likely to surface again in a few months, the long-term investor should continue to adhere to a strategy that accepts that markets are volatile and downturns are unpredictable, so it’s better to focus on what you can control and stay the course with your long-term plan.

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Van Gelder Financial