Good Evening! On Monday, the U.S. stock market was mixed as investors awaited further corporate earnings, the most recent inflation report, and an eagerly anticipated meeting between President Biden and House Speaker Kevin McCarthy regarding the debt ceiling later this week (Which this blog will be about!).
At the closing, the Dow Jones dropped 0.17%, while the S&P 500 remained largely unchanged at 0.05%. The Nasdaq Composite increased by 0.18%.
The debt ceiling was established by Congress in 1939 when the national debt was 52% of U.S. GDP, but what is the debt ceiling, and why does it matter? Well, get ready because we’re about to go over what it is, why it matters, and what it can mean going forward.
The U.S. debt ceiling represents the maximum amount of funds the government can borrow to fulfill its current financial obligations. This includes Social Security disbursements, tax refunds, national debt interest payments, and national defense spending.
Since 1939 the debt has grown to over $31 Trillion, equivalent to 124% of the U.S. GDP… And it is expected to increase despite the ongoing disagreement regarding the debt ceiling. Why? Well, congress has repeatedly increased the borrowing limit due to the absence of a viable alternative.
So why the debate? Well… Over the years, Congress has increased the borrowing limit without significant controversy until 2011, when the Treasury came close to defaulting on payments due to a battle over reducing the national debt. Congress finally stepped up and authorized additional borrowing, but not before the tussle caused the S&P 500 to experience a 15% decline in value within a month…
What else could happen? Failure to raise the limit would result in severe economic consequences for the United States and the global economy, leading to widespread hardship.
- Higher Interest Rates – Economists predict the panic sale of U.S. Treasury bonds will result in widespread rate volatility. This could result in increased mortgage rates and borrowing expenses for individuals, contributing to inflation and exacerbating economic deceleration.
- Panic in the Market – Economists are concerned that the surge in interest rates and the selling of bonds by debt holders may lead to a market panic comparable to or potentially more severe than the 2008 stock market crash.
- Long-Term – A potential default may result in a permanent credit rating downgrade by agencies and have enduring consequences on the economic position of the U.S. and the global status of the dollar as a reserve currency. A downgrade in U.S. debt will increase the country’s borrowing costs, thus putting further upward pressue on the debt and deficit. Most economists anticipate a recession if there is more economic pressure in the current year.
So what are the possible solutions? The self-imposed issue of the debt ceiling has led to unconventional solutions, such as the proposal of minting a $1 trillion coin. The US Mint is authorized to produce platinum coins of any denomination as directed by the Treasury. Theoretically, the government could increase its funds without borrowing by issuing currency.
Or… Repealing the borrowing limit could serve as a permanent measure by Congress to fix the issue. The Treasury would have the unrestricted borrowing capacity to finance the expenditures authorized by Congress, which would continue to approve deficit spending and tax cuts without debt ceiling concern. The determination of when the federal debt has become too large and the implementation of a solution will ultimately be driven by markets rather than politicians, regardless of the existence of a borrowing limit.