A Timely Update on the Debt Ceiling & Federal Spending
There is a growing concern among some investors that the debt ceiling limit (controlled by Congress) and the spending plan (controlled by the President) will collide this summer. The history of federal government budgets, spending, debt ceiling limits, and shutdowns shows these issues are complex and interrelated. They also reflect the political and economic challenges that the country faces at different times. To avoid fiscal crises and promote economic growth and stability, it is important for Congress and the President to work together to enact responsible and sustainable budget policies.
The balance of power in the U.S. Government is one of the fundamental principles of the United States Constitution. It refers to the separation of power among the three branches of the Government: the Legislative, or law-making branch that is the U.S. Congress, the Executive branch, which is headed by the President, and the Judiciary, which interprets the law at every level and settles legal disputes regarding the meaning and the application of the law. The Framers gave each branch the power to check, or stop, the actions of the other two branches in meaningful ways. For example, the President has the power to veto, or reject, laws made by Congress. Congress has the power of the purse, as it controls the money used to fund any executive actions. The President nominates federal officials, but the Senate must approve those nominations.
A Few Quick Definitions
The Federal Government budget is the plan for how much money the Government will spend and collect in a given fiscal year. The budget is proposed by the President and approved by Congress through a series of appropriations bills. The budget reflects the priorities and policies of the Government, as well as the economic and fiscal conditions of the country.
The Federal Government spending is the actual amount of money that the Government spends in a given fiscal year. The spending may differ from the budget due to unforeseen events, such as wars, natural disasters, pandemics, or recessions. The spending may also exceed the revenues that the Government collects from taxes and other sources, resulting in a budget deficit.
The Federal Government debt is the total amount of money that the Government owes to its creditors, such as other countries, investors, or the public. The debt is accumulated over time by borrowing money to finance the budget deficits. The debt is also affected by interest payments, exchange rates, and inflation.
The debt ceiling is the legal limit on how much debt the Government can issue to pay for its obligations. The debt ceiling is set by Congress and can be raised, extended, or revised as needed. The debt ceiling does not authorize new spending, but instead allows the Government to pay for spending that has already been approved by Congress and signed by the President.
A government shutdown is a different issue from a debt ceiling impasse. A government shutdown occurs when Congress does not pass or renew annual funding bills for ongoing Federal Government operations by a certain deadline. This results in some nonessential government agencies and services being closed or reduced until funding is restored. A government shutdown does not affect the payment of the debt or other mandatory spending programs. However, a government shutdown can also have negative impacts on the economy, such as reduced consumer confidence, lower tax revenues, delayed payments to contractors and beneficiaries, and disrupted public services.
The debt ceiling has been raised 78 times since 1960, usually without much controversy. However, from time to time, the debt ceiling has become a source of political conflict. If Congress fails to raise or suspend the debt ceiling before the Treasury runs out of cash and extraordinary measures to pay its bills, the Government will face a debt default. This means that the Government will not be able to pay all its obligations on time and in full, such as interest on the debt, Social Security benefits, military salaries, or contracts with vendors.
The U.S. Government has never failed to pay interest on its treasuries, but it has come close to doing so several times in the past. The most recent episode was in 2021, when the Government hit its legal debt limit of $31.4 trillion and had to rely on extraordinary measures to avoid defaulting on its obligations. Congress eventually suspended the debt ceiling until December 2022, averting a crisis. However, some analysts warn that the U.S. could face a debt default as soon as early June 2023 if Congress does not act to raise or suspend the debt ceiling again. This is because tax receipts are running much weaker than expected so far this season, reducing the Treasury's cash flow and ability to pay its bills. A debt default would have severe consequences for the economy and the financial markets, such as higher interest rates, lower growth, reduced income, lost jobs, and a possible recession.
There are two ways the U.S. could default on its debt: not raising or suspending the debt ceiling and not paying interest on Treasury bills, notes, and bonds. The first scenario would prevent the Treasury from issuing new debt to finance the budget deficits and pay for the spending that has already been approved by Congress and signed by the President. The second scenario would damage the creditworthiness and reputation of the U.S. as the issuer of the world's most trusted and liquid securities. The U.S. has never experienced the second scenario, but it has technically defaulted on its debt once before in 1979, when it failed to redeem $122 million of Treasury bills on time due to a combination of high market demand, a computer glitch, and a backlog of paperwork. The delay was only a few days and the Treasury paid a penalty interest to the affected investors, but it still resulted in a spike in Treasury yields and borrowing costs for the Government.
The U.S. Government defaulting on its debt is still considered a very unlikely event, as most observers expect that Congress and the President will eventually reach an agreement to raise or suspend the debt ceiling before the deadline. However, some are concerned that this President and this Congress may engage in political grandstanding and brinkmanship as they wage a public war of words on spending.
U.S. Treasuries are a portion of many portfolios and investment strategies. They can be much of a money market fund’s portfolio, included in most mutual funds and ETF’s and held directly in portfolios as a cash alternative that earns safe interest. They are considered the safest investment in the world with the “full faith and credit” of the United States of America behind it.
If you are concerned over the possible default of delay of payments on U.S. Treasury obligations, contact us and discuss alternatives that might be right for you.
Written by: Craig Van Hulzen | Chief Investment Officer
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