Once again, the national debt is making headline news and putting the country in a high-stakes standoff in Congress. While the thought of the government defaulting on its debt is cause for concern, the confrontation seems to have become a partisan ritual. Although it hasn’t happened yet, failure to act could have far-reaching impacts on both the U.S. and global economies. But how would this affect individuals? And what should investors expect if the debt ceiling isn’t raised?
What’s Going on with the U.S. Debt Ceiling?
It’s no secret that the U.S. government spends more than it collects in taxes. Therefore, it has to borrow money by issuing bonds in order to meet its financial obligations. However, the current debt ceiling caps the total allowable amount of outstanding debt to $31.4 trillion. And, the government reached this limit on January 19, 2023.
At this point, the Treasury has taken measures to make sure it will have sufficient funds through June. But if Congress fails to raise or suspend the debt limit, it won’t have enough to cover all its payments. An unprecedented event like this would cause rippling effects through the national and global economies, affecting all markets. The negative impacts of the U.S. government defaulting on its debt payments could trigger a deep recession amid the already tenuous economic conditions.
The extent of these effects would largely depend on how long the situation lasted. But one thing is certain; if Congress fails to reach an agreement, we will all feel the financial impact. Without the money to finance them, the government would have to slash its operations and programs – including national defense, Medicare, and Social Security. This would cause an economic freeze and leave many Americans out in the cold.
How Did We Get Here?
To understand what’s at stake, you also need to understand how we got here. Over the last two decades, Congress has signed off on legislation for trillions of dollars in additional spending which has tripled the national debt. And with the public debt now at 127% of the country’s GDP, it seems like that deficit is going to continue increasing. This alone is cause for concern. However, simply refusing to deal with the issue would lead to a government shutdown.
This is where the mandated debt ceiling becomes this issue. In the past, Congress has repeatedly had to either suspend or increase this limit to allow the government to continue operations. Since 1960, this has happened 78 times, under both Republican and Democratic presidents. It was usually done with little fuss, until 2011 when government infighting led to a downgrade in the United States’ credit rating.
Now in 2023, it seems like we are once again facing a high-stakes standoff that could have even more devasting economic effects. If the Treasury cannot maintain cash flow, it could lead to an economic freeze, millions of lost jobs, and a crippling spike in interest rates when conditions are already unstable. Tipping the scales even further could land us in the middle of a recession that will take years to recover from.
What Are the Odds of the U.S. Breaching the Debt Ceiling?
As it stands, government operations will continue until at least June 5, which is the earliest possible date the U.S. could default. Although there is always the threat that the debt limit will be binding, markets have assigned low odds that this will happen.
Looking at recent history, it’s likely that Congress will approve to suspend or raise the debt limit. The bill has already passed in the House, and will likely pass in the Senate as well. And even if it fails, the president can still raise the debt limit through an executive order.
While the national deficit is a powerful political factor, both sides of the aisle know the score and the potential risks of inaction. However, that doesn’t prevent them from political jockeying to gain the advantage.
What Can Investors Expect?
Although analysts expect both parties to come together to find a solution, the idea of a Congressional impasse is still a horrifying prospect. And it would have many significant implications for investors.
Stock Market Volatility
Defaulting would likely stoke short-term market volatility. But it’s hard to gauge just how much it would affect global markets since so much is dependent on participants. If business and consumer confidence are completely undermined, it would have catastrophic market effects.
When market conditions worsen, some investors panic and start selling off everything. If investors unload all their bonds at the same time, it could lead to a market panic and crash similar to what happened in 2008.
A Permanent Downgrade
If lawmakers can’t come to a resolution, defaulting would lead to a permanent downgrade from credit rating agencies. The loss of status would also raise the cost of borrowing, making future investments even more costly.
Higher Interest Rates
As bond market yields plummet and sell-offs continue, we’re likely to see rate volatility across the board. This would mean higher interest rates for everyone, further exacerbating the already high inflation rates.
Weakening of the US Dollar
If other countries perceive the U.S. as unreliable in paying its debts, it could reduce demand and weaken the U.S. dollar.
Increase in the Price of Gold
If we have a weaker U.S. dollar, it could lead to an increase in gold prices, at least for the short term.
Outperformance in the Defensive Sector
The increased risk of a recession could benefit more defensive equity sectors such as utilities, healthcare, and consumer staples.
The future will always be uncertain. But, there are moves you can make to mitigate your risks in the face of a recession. If you are concerned about your portfolio, it’s wise to seek expert advice. Your financial advisor can help put you in the best position to withstand potential volatility.
- Ways To Protect Your Finances From the Looming Recession
- What Would Warren Buffett Do in a Bear Market?
- 10 Investing Principles Everyone Should Understand
Jenny Smedra is an avid world traveler, ESL teacher, former archaeologist, and freelance writer. Choosing a life abroad had strengthened her commitment to finding ways to bring people together across language and cultural barriers. While most of her time is dedicated to either working with children, she also enjoys good friends, good food, and new adventures.