It’s hard to imagine a time when the United States felt new, small, or untested. We take the bonds and securities issued multiple times a week these days for granted, but just over 100 years ago, you may be surprised to know that every single debt issued was directly authorized by congress.
Of course, this solution wasn’t sustainable as the country grew and was faced with pressures related to World War I. Enter The Second Liberty Bond Act of 1917, which, removed the need for individualized approval, but also introduced a limit (i.e. ceiling) for the amount of money the United States could borrow to meet it’s existing legal obligations.
Thus, the debt ceiling as we know it today was born.
How is that different than the budget?
When the government spends more than it takes in, it creates a deficit (debt) that is sold and covered with a legal obligation to pay it back with interest.
The debt ceiling is related to the budget in the sense that budgets and spending create legal obligations that must be repaid, but it is important to mentally disentangle these concepts as the budget sets a plan for current and future spending and the debt ceiling covers the amount of money we are legally allowing ourselves to borrow to cover what is in the deficit already.
Who owns our debt?
As mentioned, each year that there is a deficit, that debt is covered (with interest) by various sources. Imagine you have a credit card and you do not pay off your balance in full. The credit card company is essentially spotting you that money with the agreement you’ll pay it back. So, who owns our national debt?
About three quarters of our debt as of January 2023 is owned domestically by companies and investors via adding low-risk securities to their investment portfolios. The 24% owned by foreign entities is dominated by stakes owned by Japan and China, which collectively make up about 25% of foreign owned debt, or about 6% of our total debt.
*Source: USAFacts.org & The US Department of the Treasury
What's the debate?
The debt ceiling has been raised 78 times since 1960 across administrations from both parties. The current debate hinges on an agreement to reduce future spending as part of the agreement to raise the current debt ceiling, and thus, our ability to pay back existing debt and avoid a default.
The stakes of the debate were heightened when an estimated date to hit the current debt ceiling was placed at June 1, 2023 by The Treasury Department. With the deadline just days away, negotiations between Speaker of the House of Representatives McCarthy, President Biden, and Democrats in leadership are more critical than ever.
Take note that this is different than government shutdowns. A government shutdown occurs when annual funding for ongoing programs expire before a new budget is passed. While that has many impacts in terms of reduced services or delayed income for federal employees, failure to raise the debt ceiling results in defaulting on existing owed payments. Because that has never happened, the exact repercussions are unknown, but it will jeopardize the credit rating of the United States, likely significantly impacting our position in markets across the globe.
3 Potential Outcomes for the Debt Ceiling Debate & What it Means for Your Portfolio [Podcast Resource: 30 Min Listen Time]
Chief Investment Officer, Peter Lazaroff, and President & CEO of Plancorp, Chris Kerckhoff, sat down to record special edition of The Long-Term Investor podcast to talk about potential outcomes of the debate well as expand on what the outcomes could mean for investors.
It’s important to understand that regardless of potential outcomes, there may be heightened market volatility. Peter and Chris unpack tips for deciphering what you can control (like the inputs and goals to your financial plan) and what you cannot personally control (the exact outcome of negotiations and how the market as a whole). They also unpack data that shows the costs of short-sighted attempts to avoid volatility.
If you’re feeling stressed about this debate, we encourage you to give this episode a listen and reach out to your wealth manager with any questions. If you aren’t a Plancorp client, but potential market volatility has you wondering if now is a good time to seek professional guidance with your financial plan, get started by taking a simple 2-minute financial plan analysis today.