The Debt Ceiling Distraction: A Manufactured Crisis
The United States Congress first established a limit on government borrowing in 1917 to finance the country's involvement in World War I. Since 1960, the debt ceiling has been raised 78 times to accommodate the government's growing debt obligations over time. Historically this budgeting maneuver has been procedural and uncontroversial. However, recent rising debt-to-GDP levels and partisan politics have turned procedure into brinksmanship, which is on display again in the current debt debate.
You may recall a prolonged debate in Congress over raising the debt ceiling in 2011 led Standard & Poor’s to downgrade the United States' credit rating. Market volatility ensued witProfileh the S&P 500 dropping early 17% in just 11 trading days. In 2013, another impasse over the debt ceiling led to a 16-day government shutdown. It appears we’re approaching a similar scenario unless Congress comes to a resolution.
The U.S. once again hit its debt ceiling on January 19th and the Treasury Department enacted “extraordinary measures” to avoid or delay a technical default. Early measures often include drawing from cash and other emergency reserves. More dramatic measures include delaying federal employee retirement payments or even shutting down portions of the federal government. According to Treasury Secretary Janet Yellen, the U.S. government may exhaust these measures and potentially default on its obligations as early as June.
A default on U.S. debt would be unprecedented in modern times. With the U.S. dollar largely regarded as the reserve currency of the world and the Treasury market one of the deepest and most secure, a default would likely have wide-reaching effects. That said, we believe the debt ceiling is more of a distraction than anything else for long-term investors. Here’s why:
Most of us would probably agree that recent actions from politicians have done more to shake confidence in bipartisan resolution than establish it. This is the primary reason we believe this issue is likely to persist or even escalate as summer draws near. However, if market volatility, delayed tax refunds, and potentially missed Social Security payments (among other issues) occur as a result of Congress’ intractability, it will be felt by voters of both parties creating an incentive for resolution.
Ability and willingness are, of course, very different things when it comes to a debt crisis. Ultimately, such actions erode faith in the U.S. Treasury system and may have long-term implications, but it is less likely to evolve into a systemic risk than if the U.S. government were truly insolvent. Moreover, the resolution to the crisis is, in theory, easily and quickly attainable.
While markets have recently experienced a bit of reprieve from volatility as the grip of inflation begins to loosen, we anticipate heightened discord could return in the event of a protracted debt ceiling debate. Politics aside, we believe it is in the best interest of investors to tune out the noise from these manufactured crises and stay the course. Volatility is a normal part of investing and long-term investors, whose portfolios take into consideration their long-term goals and current needs, can use it to their advantage by regularly rebalancing.
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