For months, the debt ceiling problem has sounded ominous. With a make-or-break deadline nearing, here’s a dispassionate summary of what’s going on.
To start, remember this famous quote: “Americans can always be relied upon to do the right thing — having first exhausted all possible alternatives.” Often mistakenly attributed to Winston Churchill, scholars say Israeli diplomat Abba Eban is the correct source of the quote. Regardless of who said it, the statement has been accurate since 1776, and it is wise for investors to plan on having it apply to resolving the debt ceiling. This is not to say the national debt limit is not a serious threat to U.S. financial stability.
In fact, the debt problem already has made investment markets nervous. The spread between the yield on a one-month and three-month Treasury bill recently surged like never before. The yield on the two short-term instruments historically stayed in lockstep. Which makes sense. The only difference between the 90-day versus 30-day T-bill is how long you must hold them to collect your yield. So, they should have almost the same yield. But fear of the debt ceiling problem has sent the price of a 30-day T-bill skyrocketing versus the 90-day issue.
Wall Street — mutual funds, pension funds, and other institutional investors — are acting rationally because there is a chance something could go wrong, if America waits too long to do the right thing and agree on a debt limit putting the nation on stronger financial footing.
Exactly when the government will run out of cash is uncertain. Depending on accounting tactics, it could be in June or not until September. Wall Street is also nervous that a debit limit agreement will come at the last moment possible and accidentally cause the U.S. Treasury to be late in meeting some of its obligations.
The politics are complicated by the financial cliff projected by the non-partisan Congressional Budget Office. In 2023, the Federal debt held by the public is equal to 98% of U.S. gross domestic product but projected to reach 118% of GDP in 2033. That’s higher than ever before. Moreover, from 2034 to 2053, the federal debt is expected to equal 195% of GDP. At that point, interest payments on the debt would dig the country into a financial hole it cannot climb out of.
How can the problem be solved? A tax increase could do it, but no one wants higher taxes. Nonetheless, it’s worth noting that raising the federal tax burden by 2% would divert the U.S. from the impending fiscal cliff, according to independent economist Fritz Meyer. He says the tax burden in American is substantially lower than in other wealthy nations, such as Germany and France. To be clear, a permanent resolution to the debt limit crisis, that’s dogged the nation in recent years, is not so hard to engineer.
Although we’d like to think America will once again do the right thing after exhausting all possible alternatives, we will be closely monitoring the debt ceiling situation and its impact on investment prices. Feel free to contact us with any questions or comments.