The raising of the national debt limit is back on the front pages as the hot topic du jour. In order for the federal government to continue paying its expenses, Congress must vote to increase the nation’s borrowing cap, known as the Debt Ceiling. Negotiations between House Republicans and President Biden drag on while Treasury Secretary Janet Yellen has warned that the country could run out of borrowing authority by June 1 if the debt limit is not increased. If this sounds familiar, it’s because it is. Here is a little background on why we have to endure this maelstrom yet again.
What is the Debt Ceiling?
The Debt Ceiling is a cap on the amount of debt that the US Treasury is allowed to borrow. Because the US government normally spends more than it receives in revenues, the national debt is growing, and we keep hitting this limit. Congress is constitutionally required to authorize the issuance of debt, which is needed in order for the government to meet its obligations such as Social Security and Medicare benefits, federal and military expenses, interest on the national debt, and other payments.
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The history of the Debt Ceiling
Before World War I, Congress had to authorize every single auction of Treasury securities to fund government spending. In order to expedite funding the war, Congress passed the Second Liberty Bond Act of 1917, which allowed the Treasury to issue bonds and take on other debt without specific Congressional approval, as long as the total debt fell under a statutory debt ceiling of $11.5 billion. During World War II, Congress raised the debt ceiling to over $300 billion over four consecutive years. After the War ended, Congress lowered the debt ceiling, but it has increased ever since and now stands at $31.4 trillion.
What happens if the debt limit isn’t increased?
Since the government is spending more than it’s taking in, a failure to raise the debt limit would mean that the government could not pay all of its bills. Its operations could be disrupted, and if the disruption continued, millions of government workers and contractors could be laid off or furloughed. It’s unlikely that things like U.S. Treasury Bond debt or Social Security payments would be delayed, but, given the variable timing of cash receipts, this can’t be ruled out. If this worst-case scenario occurred, the economic damage could be severe and long-lasting as the U.S. credit rating and its status as the world’s reserve currency could be compromised.
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Why hasn’t the stock market reacted if the result of a default would be so severe?
In part, this is because we’ve seen this play out several times in the past 12 years. In 2011, when the debt limit was raised within hours of defaulting, the investors did panic and losses in stocks were large, but markets recovered relatively quickly. The tension and drama will run high as we approach the “X-date,” (the date the government truly runs out of cash) without a resolution, but most analysts who follow politics in Washington expect that this will be resolved before a default actually happens.
At the end of the day, no one in Congress wants to be responsible for the unimaginable consequences we would face if the U.S. defaulted on its debt obligations for the first time in its history. In all likelihood, the debt limit will be raised, the government will NOT default on its obligations, and investors will move on to whatever the next headline crisis is.
What should I do to prepare for a possible default?
In the unlikely event of a default, the credit and debt markets could be disrupted, but it would likely be a short-term disruption. As long as you have reserves in your savings or checking account, there is no need to worry about it disrupting your finances. You can focus on the long-term and ignore these tea-pot tempests. Our advice: don’t click on the scary headlines, and don’t believe half of what you read or see, especially in partisan media outlets.
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