The debt ceiling is an absolute maximum amount of money a government can borrow at any given time. Only two countries in the world have an absolute debt ceiling, Denmark and the United States of America. Most other countries set their debt ceiling limit as a percentage of gross domestic product.
The debt ceiling was established in the U.S. in 1917 to help fund World War I. Only Congress can raise or lower the debt ceiling. Since 1960, Congress has acted 78 times to raise the limit, 49 times under Republican presidents and 29 times under Democratic presidents. The most recent debt ceiling increase was in December 2021, when Congress increased the ceiling to its current limit of $31.46 trillion.
The current total outstanding debt sits at around $31 trillion. With the U.S. government running a deficit in almost every single year, this does not leave much additional room to borrow. Recently, Treasury Secretary Janet Yellen said the government could run out of borrowing capacity as soon as June 1, 2023.
The tight deadline to increase the debt limit has political parties facing off against each other and infighting amongst themselves. Historically, debt ceiling negotiations have been nothing more than a ploy to get something that each party wants. There is no reason to believe that this time will be different.
So far, there is no indication that either party is willing to budge on their demands for raising the debt ceiling. However, on April 26, 2023, the Republican controlled Congress passed a bill raising the debt ceiling, but the bill included significant spending cuts that the Democrat-controlled Senate and President Biden will not agree to. Negotiations are sure to heat up in the coming weeks and are expected to be extremely tense with each side jockeying to get what they want.
Meanwhile, the clock is ticking ever so closely to the June 1st deadline that Treasury Secretary Yellen has recently established. Should the U.S. hit the debt ceiling limit without any extension, the consequences could be extremely negative and would qualify as one of the worst “unforced errors” in financial history. First, it is unclear how the government would handle paying its bills. It could ‘prioritize’ by insuring debt service payments and debt maturities payments are made first to avoid a default. This would mean reducing payments to Social Security, Medicare and potentially government employees, which could lead to a severe economic slowdown. The government could also decide not to service its debt, which would likely be a disastrous scenario. U.S. government debt is considered to be one of the safest investments in the world. Not servicing the debt would lead to a crisis of confidence and could lead to significantly increased borrowing costs in the future, if investors are even willing to buy U.S. debt.
The lack of leadership in Washington and the divisive nature of our current government is affecting the American people. Short-term funding costs for the U.S. government have risen on fears over the debt ceiling. This is costing additional money in the form of higher interest expenses for taxpayers. Consequently, confidence in the U.S. servicing its debt could wane, leading to higher future funding costs.
The implications for investors over the debt ceiling are extremely important. With just a few weeks to go until the ceiling is hit, investors are starting to get anxious. We will likely see increased volatility across the market in the coming weeks as we approach the June 1 deadline. Of course, news of a resolution could break at any time. Maintaining a well-diversified portfolio along with some liquidity should position investors well to weather the potential volatility. If there is a meaningful pullback in the market as a result of debt ceiling negotiations, we believe that is a buying opportunity for investors. As Warren Buffett said at the recent Berkshire Hathaway annual meeting, “What gives you opportunities is other people doing dumb things.” In this case, the U.S. Government messing around with the debt ceiling could certainly be classified as a dumb thing.