The pressing issue at hand is that the federal government will soon run out of available cash to meet its spending commitments. And the nation's debt capacity to borrow more cash, currently capped at $31.4 trillion, was exhausted on Jan. 19.
Congressional Republicans and Democrats are engaged in a standoff over whether spending cuts will be attached to a debt-limit increase or, alternatively, a "clean" increase of the debt ceiling (Biden's preference) will happen before spending talks.
Since Jan. 19, the Treasury Department has used "extraordinary measures" to come up with enough cash to pay the government's bills on time. While it's difficult to precisely nail down when these measures will be exhausted (the so-called x-date), Treasury Secretary Janet Yellen has said it could be as early as June 1.
Read on for details about the national debt limit and what investors should be aware of as the debt-ceiling x-date nears.
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What triggered Yellen's ominous forecast was the
government's weak tax receipts in April, which tallied 35% lower than the
receipts received in April 2022. And while the x-date could occur in early
June, other sources, including Moody's Analytics, point to late July as a
possibility because the Treasury will receive a cash infusion from non-withheld
tax revenue around June 15 of this year.
McCarthy put forward the Limit, Save, Grow Act of 2023 as a
preventative measure on April 19. The legislation aims to suspend the federal
debt limit through March 31, 2024, or increase the federal debt limit by $1.5
trillion, whichever comes first, and curb government spending by $4.5 trillion
over the next decade.
While Biden opposes the core details of this bill, which
passed in the House on April 26, there is now a framework on which political
figures on both sides of the aisle can negotiate the finer points of how the
debt-ceiling limit will be managed in the coming weeks. Also at issue are the
cascading effects of those discussions on the government's spending habits in
the future.
Seventy percent of registered voters prefer a government
compromise on the debt-ceiling debate, according to an NPR/PBS NewsHour/Marist
national poll conducted in late February. Still, there are no guarantees that
the debt-ceiling stalemate will resolve quickly.
Read on for details about the national debt and what
investors should be aware of as the debt-ceiling x-date nears:
- How big is the national debt,
really?
- Effects of debt-ceiling gridlock
on investors.
- The debt-ceiling debate cycle.
- Today's debt-ceiling debate vs.
past conflicts.
- Long-term consequences of
inflated U.S. debt.
How Big Is the National Debt, Really?
The massive amount of U.S. debt is hard to visualize in
scope and dimension. Just how much is $31.4 trillion?
Here's one way to think about it: Earth is approximately 93
million miles away from the sun. If it were even possible, a spacecraft would
need to take nearly 169,000 round trips to the sun to log 31.4 trillion miles.
Expressed another way, the nonpartisan Peter G. Peterson Foundation estimates
that if every single American decided to pitch in and pay off the national debt
today, the cost would be more than $94,000 per person.
From 2013 through the end of 2022, the U.S. debt grew by
nearly 86%, according to Treasury Department data. The debt-to-gross domestic
product (GDP) ratio, a bellwether metric for a country's ability to pay down
its debt, also grew from 100% in 2013 to 124% in 2022.
Effects of Debt-Ceiling Gridlock on
Investors
Markets as a whole are acutely aware of developments
related to the debt ceiling. "Bond markets experienced
utter carnage in 2022 for a host of reasons, including long-term concerns about
newly accumulated government debt," says Scott Knapp, chief market
strategist at CUNA Mutual Group.
"There is a wide divide between Republicans who want
spending cuts and Democrats who want to raise the debt ceiling, which is
pointing to a long, drawn-out fight over the budget and debt ceiling,"
says Lauren Goodwin, economist and director of portfolio strategy at New York
Life Investments. "We expect disaster to be avoided, but there are costs
to 11th-hour brinkmanship."
Plummeting household and business confidence amid uncertainty about
asset prices, borrowing costs and economic activity could result
from a debt-ceiling crisis, Goodwin says. "Worse even, a debt-ceiling
fight this year would likely increase the effects of the economic slowdown and
even pull forward recession timing," she adds.
The Debt-Ceiling Debate Cycle
When it comes to raising the roof on U.S. debt, there
appears to be a rinse-and-repeat pattern in play. Since 1960, Congress has
produced 78 separate measures to raise, extend or amend the debt limit,
according to the Treasury Department's records. That's an average of more than
one piece of debt-ceiling legislation per year over the past six decades.
Congress has never lowered the debt limit.
Because congressional debates about the debt ceiling are
often mundane, investors don't usually see an immediate effect from the
process. There are some notable exceptions, however. Take, for example,
investors' cliffhanger experience in 2011, when congressional discussions about
the budget reconciliation process stalled within the House and Senate chambers.
The ensuing gridlock soured investor sentiment, and the S&P 500 fell
17.4% from May 2 to Oct. 4, 2011.
Further, America's credit rating was downgraded by Standard
& Poor's from AAA to AA+ for the first time since 1917 on Aug. 6 of that
year. The Bipartisan Policy Center estimates that the debt-limit debate in 2011
increased U.S. borrowing costs by $18.9 billion.
Today's Debt-Ceiling Debate vs. Past
Conflicts
While many portfolio
managers and strategists do not anticipate that this year's
debt-limit debate in Congress will mirror what happened in 2011, they quickly
point out that the duration of the discussions could have unintended
consequences in the market.
Knapp remarks, "Gridlock regarding the debt ceiling
creates uncertainty that could eventually roil markets. So far, that hasn't
happened, likely due to investors' belief that a solution to the problem will
be found before a default occurs."
"We anticipate downside risk from debt-ceiling
negotiations should they drag. Slowing economic growth and investor complacency
from early 2023 could compound the volatility,"
says Jon Maier, chief investment officer at Global X ETFs.
Volatility is not exactly a new thing for the S&P 500.
From 1957 through the end of 2022, the S&P has ended the year in the red 18
times, nearly 28% of the time. What's intriguing, though, is that following
those 18 negative-return years, it snapped back with positive returns 14 times.
In fact, since 1957, there have only been three periods in which the S&P
500 has experienced consecutive years of negative returns (1973-1974, 2001-2002
and 2002-2003), according to data from Statista and Macrotrends.
But even if debate tensions fizzle before June and the
stock market averts excessive volatility, there are other, longer-term
challenges that the national debt poses for investors.
Long-Term Consequences of Inflated
U.S. Debt
"Long-term debt sustainability is pure
economics," Goodwin says. "And, in a short period of time, tailwinds
for U.S. debt sustainability have turned to headwinds, putting this debate back
on investors' map."
Long-term issues associated with the size of U.S. debt
include debt-serving costs that will rise in coming years and potentially
weakening demand for Treasurys in
a global economy that has alternative fixed-income options with positive
yields, Goodwin says.
"Declining demand, even amid steady supply, would put
durable upward pressure on U.S. bond yields,
all else equal," Goodwin says. "In other words, the U.S. might see an
increase in its term premium – a sea change in global investing." Term
premium is the higher return that investors receive for committing to a
long-term bond instead of rolling over shorter-term debt.
Takeaway
Perhaps Congress will once again find a way to hit the
snooze button on the debt-ceiling debate and reach an agreement that will
appease both political parties for now. And while the market may cheer that
outcome in the short run, keen investors will remain curious about how the
government will follow up. Hard questions remain about the size of the national
debt and what it may mean to future generations if nothing substantial is done
about it.
Updated on May 11,
2023: This story was
previously published at an earlier date and has been updated with new
information
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