Weekly Wisdom – April 20, 2023

By Hightower Great Lakes on April 19, 2023

What is the Debt Ceiling?

The debt ceiling is the maximum amount the United States government is authorized to borrow to meet its existing legal obligations, including Social Security and Medicare benefits, military salaries, interest on national debt, tax refunds and other payments.[1]

Lawmakers must raise or suspend the ceiling before the Treasury Department can issue more debt. The debt ceiling does not authorize new spending, but rather, allows the Treasury to pay for expenses the government has already authorized.

The worst-case scenario in which the debt ceiling is not raised would cause the government to default on its legal obligations – which is unprecedented in American history – and would cause various other negative contagions across the economy.

While the worst-case scenario is dire, Congress has always raised the debt ceiling when called upon and has acted 78 separate times since 1960 to extend or revise the definition of the debt limit; we view the chance that the U.S. government defaults as extremely unlikely.

Implications of Default

If the debt ceiling is not raised, the government would not be able to borrow funds to pay bills; it would have to suspend pension payments, withhold or cut the pay of soldiers and federal workers, and/or delay interest payments, which would constitute a default.

A default would, at the very least, rattle investor confidence in the security of U.S. Treasuries, which would likely cause a massive selloff in those securities and create an extremely volatile market.

Rating agencies would also cut the U.S. credit ratings multiple notches; for example, in 2011 S&P cut the U.S. credit rating from AAA after it came within days of breaching obligations, so an actual default would cause multi-notch downgrades.

In 2011, to avoid default, the agreement contained $2.1 trillion in spending cuts to be implemented over 10 years, which was comparable to the debt increase, and no change in taxes. The U.S. has defaulted on its debt just once before, in 1979; this was a technical bookkeeping glitch that resulted in delayed bond payments but was quickly rectified. The U.S. has never intentionally defaulted on its debt. The current debt ceiling was passed in 2021.

Nonetheless, Congress needs to create a new budget; because Congress is Congress, we expect this conversation to bubble over the next couple of months as deficit grows closer to surpassing $31.4 trillion. The U.S. government is currently within a “‘debt issuance suspension period,’ during which, under current law, it can take well-established ‘extraordinary measures’ to borrow additional funds without breaching the debt ceiling.”

The Congressional Budget Office (CBO) projects the U.S. to reach its debt ceiling between July and September, pending any new budget passing. This projection depends on variables like tax receipts, and the CBO will release another estimate in May that takes into account 2022 tax revenues. Goldman Sachs analysts said weak tax collections so far in April indicate a higher probability that the debt ceiling is reached sooner.[1]

Today, House Speaker Kevin McCarthy is introducing a bill for a one-year extension to the debt ceiling, paired with a set of spending cuts. The proposal is not expected to pass the Senate and unlikely to pass the House without bipartisan support. Both sides do not appear close on an agreement.

Rising interest rates are also impacting future deficit projections, as the CBO projects an $18.8 trillion deficit over the next 10 years, 20% higher than last year’s estimate. The Fed does not seek to play a role in the debt ceiling debate, protecting its political independence.

Likelihood of Default

The most recent debt-ceiling debate was resolved in 2021 when a deal allowed the ceiling to be raised with a simple majority vote in the Senate instead of the typical 60 votes required. The situation is more complicated this time around as the Democrats do not control both houses.

Another scenario for staving off a default would be one California encountered around 10 years ago. The state issued IOU’s in lieu of payments for a stretch of time and all debts were eventually repaid. As unlikely a scenario as it is, if the debt ceiling is not raised in time, we do not think the U.S. Government will stop paying Treasury debt first.

At the end of the day, we view the chance of a default as minuscule, but understand the far-reaching implications should it not be raised. This is a chance for some outspoken members of Congress to make their views heard about concerns related to the level of debt. At the end of the day, it would be politically detrimental to allow the U.S. Government to default, therefore, in no one’s best interest.

Click here to read last week’s Weekly Wisdom (4/14).

Disclosures

Investment Solutions is a group comprised of investment professionals registered with Hightower Advisors, LLC, an SEC registered investment adviser. Some investment professionals may also be registered with Hightower Securities, LLC, member FINRA and SIPC. Advisory services are offered through Hightower Advisors, LLC. Securities are offered through Hightower Securities, LLC.

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This document was created for informational purposes only; the opinions expressed herein are solely those of the author(s) and do not represent those of Hightower Advisors, LLC, or any of its affiliates.

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¹ Source: U.S. Treasury Department. As of April 18, 2023.

² Source: Yahoo! Finance. As of April 18, 2023.