What’s behind the recent “debt ceiling drama”?
Bryan T. from Erie, PA asks: Hello Mitch, after going through this debt ceiling drama and seeing volatility in the stock market, I’m wondering if we’re going to see a replay come December when the government runs out of money again. Your thoughts?
Thanks for sending in your question, Bryan. I’m sure many other readers share your concerns, and you are correct to point out that we’re likely to have a “here we go again” moment in December, when this issue must be revisited by Congress.
Before I offer a few thoughts on the debt ceiling issue specifically, I think it’s important not to draw a straight line between September volatility and the debt ceiling. I would argue that the two issues are not necessarily closely related. September volatility, in my view, was more closely tied to the China Evergrande issue, the stock market pricing-in Fed ‘tapering’ later in the year, and perhaps some short-term growth concerns tied to the Delta variant. The debt ceiling issue was in the mix, in my view, but not front-and-center by any means.
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One reason I do not put too much weight on the debt ceiling issue is that the markets have seen this song-and-dance before, and the actual risk of the U.S. defaulting on debt is far lower than advertised in the media. The news made it seem as though the U.S. was teetering on the edge of default for the first time in history, but that was not the case at all. Not even close.
In order to truly understand the debt ceiling issue and its risks, one must differentiate between ‘government obligations’ and debt payments due. Government obligations – like Social Security payments, child tax credits, other entitlements – are not debts. Not paying entitlements on time could seriously impact American families that rely on them, but it does not equate to a “default.” If you send your daughter in college $500/month for living expenses, and you are late one month or miss the payment entirely, you are not “defaulting.” If you miss a mortgage payment, however, there are real consequences to your financial and credit standing.
The debt ceiling issue has similar dynamics. Raising the debt ceiling means meeting government obligations, like Social Security payments. But the U.S. Treasury does not need Congress’s authorization to make interest payments on debt, nor does it need Congressional approval to issue new debt to refinance a maturing bond. Not making these debt payments would put the U.S. in default, which would be very damaging to the markets, in my view. But that’s not the issue in the debt ceiling debate, which is really focused on entitlement payments.
Come December when the debt ceiling issue may return to headlines, I’d encourage you to remember this distinction between ‘obligations’ and ‘default.’ To be fair, missing obligations/entitlement payments could impact sentiment and result in volatility, but it is not the same thing as default, which would be a credit event. At the end of the day, in order for the U.S. Treasury to stay current on debt interest payments, it can use tax revenues, of which there are plenty to cover expenditures:
I would also encourage you to focus on the fundamentals when volatility is strong, especially if you are working towards a successful retirement. Our guide, How Solid is Your Retirement Strategy3, will provide valuable and practical ideas to help build a “weatherproof” retirement strategy that can potentially protect your retirement nest egg from any storm that can threaten your financial security.
If you have $500,000 or more to invest, download our free guide, How Solid is Your Retirement Strategy3.
2 Fred Economic Data. September 30, 2021. https://fred.stlouisfed.org/series/W006RC1Q027SBEA#0
3 ZIM may amend or rescind the guide “How Solid Is Your Retirement Strategy?” for any reason and at ZIM’s discretion.
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