It seems the debt ceiling issue has become one of the favorite ways that many media outlets are using now to draw your attention, using scary headlines like “debt showdown”, “looming economic crisis”, “battle of the budget”, etc. You may have also heard about the “X-date” which is the date on which the US Treasury Department estimates that it will no longer be able to pay all of the government's bills in full and on time, including payments for Social Security, Medicare, and other entitlement programs, as well as payments to contractors and interest on the national debt. This date is also known as the "drop-dead" date or the "default date" because it is the date by which Congress must act to raise or suspend the debt ceiling, or risk the United States defaulting on its debt obligations. US Treasury Secretary Janet Yellen said this “X-date” could come as early as June 1, but it may be that it could be pushed out several weeks beyond that.
The fact is that the US hit its debt limit of $31.4 Trillion back in mid-January and has been relying on funds in the Treasury General Account and so-called “extraordinary measures” to fund its ongoing operations since then.
Another fact is that we’ve been here before with the debt ceiling raised or suspended over 100 times since World War II and under every president since 1959 to allow the government to continue to operate. There really shouldn’t be any debate, but it has gotten political with both sides wanting something and, of course, we know that Congress only works well when there’s a deadline. Sounds like a real conundrum, right?
Here are a few scenarios on how this could play out:
- Congress raises debt limit with no conditions. Democrats want this, but Republicans want to seize on the debt limit as a tool to try to get additional concessions on spending.
- Negotiated raise. Debt limit gets raised while also spending getting cut.
- Executive action to bypass the debt limit. The Biden administration could declare the debt ceiling unconstitutional, arguing that it violates the 14th Amendment which says that “the validity of the public debt of the US shall not be questioned.” This would most likely be challenged by the Supreme Court, but it would buy time allowing government to function during that window.
- Prioritizing payments by the Treasury. This could also buy time.
There’s also been “silly” talk of the government minting a Trillion Dollar Coin, but that’s already been dismissed by Janet Yellen.
The good news is that both sides are now in talks and appear to want to get something worked out. As such, we think there’s a very strong probability that a negotiated deal scenario takes place - might not be until the very last minute - but we think it does indeed get done. Experts we follow agree putting a deal at about an 85% probability.
If not, any Treasury Bill payments due after X-date will be DELAYED, but ultimately paid with interest once the debt ceiling is inevitably raised or suspended. In other words, Treasury Bill investors will be made whole. That’s good to hear.
Keep in mind that a default is unprecedented and certain to create some havoc. If you take away the trust in the financial system or U.S. debt, there are tremendous ripple effects. The banks could freeze up as there would probably be little borrowing. The stock market would likely go down. The last two debt ceiling scares of 2011 and 2013 saw S&P500 declines of 19% and 6%, respectively. That said, the declines were pretty short-lived and markets fully recovered. Hence, there’s liquidity risk, collateral risk, and economic risk at stake here – everyone knows this needs to get hashed out in a timely manner including the circus in Washington DC.
We think the best thing to do is stay disciplined and try not to get caught up in the circus-like atmosphere. Just like the yearly carnival that comes to town and creates some craziness, it eventually leaves and things return to normal. In other words, just like every other mini crisis the market faces, it always passes and inevitably reaches new highs. For the long-term investor, you should stay the course and try not to get caught up in the short-term ridiculousness.