By Dr. James M. Dahle, WCI Founder
We have been getting a lot of questions about the debt limit crisis in Washington and how it affects investments such as Treasury bonds, the TSP G Fund, and savings bonds like I bonds. I'm kind of surprised how many we're getting (you'll soon see why), but Josh, our content director, says I have to write a post about it. So, here's what to know about the debt limits and how they could affect your investments.
Why Is There a Debt Limit?
The first thing you need to understand is that this “debt limit” thing is completely artificial, and it could be changed by Congress at any time. In 1917, Congress passed the Second Liberty Bond Act to help finance World War I. As part of that act, a “debt ceiling” was put in place. This rule basically said, “The US government can only borrow this much money.” That number wasn't indexed to inflation or anything, and it has periodically been raised by acts of Congress. In fact, during the last 106 years, it has been raised AT LEAST 90 times . . . by Congresses controlled by both major parties with presidents from both major parties. This rule is completely separate from the spending authorizations that Congress does when it passes bills into law. Raising the debt ceiling is merely paying for the spending that Congress has already authorized.
Imagine you ran your family budget this way. First, you decide what to spend money on. Then, you spend it. Then, you freak out when you find out how much money is on the credit cards because you and your spouse agreed not to borrow more than $10,000 on your credit cards. So, you have an argument that all of the neighbors can hear. You blame your spouse for their spending. They blame you for yours. All at the top of your voices.
Finally, in the end, you are forced either to spend less money so you can keep your “less than $10,000” rule in place, or you just agree to change the rule. Most of the time, the two of you just quietly change the rule. That argument is pretty much what's going on in Congress right now. If it is the first time you've heard this argument, you might think something terrible is going on. But if you've lived in the neighborhood for long, you know this couple screams at each other every month on budget night and they're still together after a decade.
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Recent Debt Limit Crises
In more recent years, politicians (and let's be honest, it's mostly Republicans) have been making a stink about these debt limit increases. Instead of (or in addition to) making the stink when the spending actually happens at the restaurant and mall, they make a stink when the credit card bill gets opened on budget night. And they actually refuse to increase the $10,000 credit card limit unless their spendthrift spouse agrees to not order so many appetizers or to buy the latest tech gadget. This happened in 1995, 2011, 2013, 2021, and again in 2023.
Sometimes, it drags on for quite a while. If it drags on long enough, the federal government “shuts down.” But even the threat of a crisis or shutdown increases borrowing costs for the country. It's just like what happens when that couple doesn't pay their credit card bill because one of them is mad that the other pushed them over the $10,000 limit. All of a sudden, they start getting fees and higher interest rates from the bank. Well, that's exactly what happens to the United States. Political brinksmanship has its costs.
Extraordinary Measures
The first thing that happens in a debt limit crisis is that Congress lets the deadline pass for increasing the debt limit. However, that is not when the “government shuts down.” That happens a few months later after the US government has used all of its “extraordinary measures” to give Congress a few more months to come to an agreement that raises the borrowing limit. What are these extraordinary measures? They are essentially accounting maneuvers done by the Treasury Department. It moves money out of one place on the government ledger (replacing them with an IOU) and sends the money to another place on the ledger, so the government can continue to operate. These measures include:
- Prematurely redeeming Treasury bonds held in federal employee retirement savings (later replacing them with interest)
- Halting contributions to certain government pension funds
- Suspending state and local government series securities
- Borrowing money set aside to manage exchange rate fluctuations
These measures get used all the time these days. They were first used in 1985—and have been used seven times since 2011. Each time, once the “crisis” passed, the money was moved back to where it was supposed to be and all the IOUs were paid off with interest.
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Government Shutdowns
If the political brinksmanship continues, the Treasury eventually runs out of extraordinary measures and the government runs out of money and “shuts down.” It actually didn't used to shut down when that happened. Since Congress changed the appropriations process in 1976, there have been 22 funding gaps, but there have been only 10 instances when federal employees were told to stay home and not come to work (i.e. a shutdown). In 1980, the attorney general issued a legal opinion that required the government to shut down when there was a funding gap lasting longer than a few hours. It took a decade, but since 1990, the opinion has pretty much been followed. Some of the longer shutdowns have been:
- 1995-1996: 21 days
- 2013: 16 days
- 2018-2019: 35 days
If you think back, there is a good chance that you were inconvenienced in some way or another by one of these shutdowns. Maybe you couldn't get into a national park. Maybe a response from the IRS was delayed. Maybe you couldn't enroll in Medicare. However, there were a lot of “essential services” that were never shut down. These include:
- Active duty military
- Border protection
- In-hospital medical care
- Air traffic control
- Law enforcement
- Power grid maintenance
- Mandatory spending not subject to annual appropriations (Social Security, Medicare, Medicaid)
- Activities funded by permanent user fees not subject to appropriations (immigration services paid by visa fees)
- Congress continues to get paid (no surprise)
What Are the Politics Behind THIS Crisis?
Currently, the House is controlled (barely) by Republicans, the Senate is controlled (barely) by Democrats, and the White House is controlled by Democrats. While Senate Republicans balked at the last debt limit increase in 2021, they were powerless to really do anything about it. Now, House Republicans are not. To make matters worse, Speaker Kevin McCarthy barely managed to get into power by promising all kinds of things to the far right wing of the Republican party, one of which was additional fiscal responsibility (i.e. getting Congress to spend less by creating a debt limit crisis.)
The White House and Senate Democrats are insisting the debt limit just be increased as a “business as usual” move and are refusing to negotiate about spending. Senate Republicans (and moderate West Virginia Democrat Senator Manchin) are promising there won't be shutdown. House Republicans are threatening catastrophic debt default in order to force some moderate spending cuts. There is talk of perhaps a “debt commission” being formed in exchange for this debt limit increase.
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What Do I Think Is Going to Happen?
As I peer into my very cloudy crystal ball, I suspect this crisis will come to an end prior to a government shutdown. Best estimates are that the “extraordinary measures” will give lawmakers until June to come to an agreement. I suspect they will use most of that time to raise the limit.
How Is This Going to Impact Investments?
One of those extraordinary measures is borrowing money from the Federal TSP to pay current government bills. While I'm not 100% sure on what the government is doing, I think it's mostly raiding part of the F Fund (which holds treasuries) and the G Fund (all treasuries.) These investments have always been backed by nothing but the faith and credit of the US government. So, when the government seems a little less likely to pay its bills, these investments don't seem worth as much as they might have been before. The same principle applies to all Treasury bonds (including TIPS) and savings bonds (including the recently popular I bonds). Should you really still put money into government debt instruments if the government is this flaky? Well, I can tell you what I did and you can read from that what you want:
- TSP G Fund: My entire TSP balance is still invested in the G Fund, just like it was before the crisis
- I Bonds: We bought $30,000 more in I bonds in January ($10,000 each for Katie and me and another $10,000 for the trust)
- TIPS: We bought $100,000 in 10-year TIPS from TreasuryDirect at the January auction
Does it sound like we're particularly worried that this debt crisis is somehow different from the previous ones? Probably not. When we drafted our written investing plan, we did not put a provision in there to change the plan in the event of a threatened government default or a debt limit crisis. We wrote that we would stay the course through thick and thin, and that's what we're doing. We suggest you do the same.
In the words of Aragorn, son of Arathorn:
“My brothers. I see in your eyes the same fear that would take the heart of me. A day may come when the courage of men fails, when we forsake our friends and break all bonds of fellowship. But it is not this day. An hour of wolves and shattered shields when the Age of Men comes crashing down, but it is not this day! This day, we fight! By all that you hold dear on this good earth, I bid you stand, Men of the West!”
A day may come, when we will default on our national debt, but it is not this day! Stay the course.
The Real Economic Effects of All This Nonsense
However, just because you shouldn't bail out of all of your US government securities does not mean that this political brinksmanship will not have any effect on your investments. Markets hate uncertainty. If the US government eventually has too high of a debt-to-GDP ratio, the likelihood of default could rise. More likely, higher inflation could be used to reduce the real government debt, and that could decimate the value of all kinds of investments—especially long-term nominal treasuries.
Government shutdowns also have economic effects. In 2013, 1.3 million workers had their payments (i.e. paychecks) delayed, and 800,000 were furloughed. While this didn't affect active duty and VA docs, it certainly affects a lot of people at least in the short term. They spend less. They raid their savings more. Macroeconomically, a shutdown lasting just a few weeks dropped GDP by 0.1%-0.2%, which is a pretty big deal. Decreased growth makes your stocks and real estate worth just a little bit less than they otherwise would be.
The truth is that both sides are right. The Democrats are right that the debt ceiling needs to be increased. Congress already spent the money; they're just acknowledging that fact now. However, the Republicans are also right that even a government with unlimited borrowing power cannot borrow too much without killing the goose that lays the golden eggs. Compromise and a sensible middle path are the order of the day and really the only thing that can be done in the end. So, once they try everything else, they'll do that.
What do you think? How is the debt ceiling crisis affecting how you invest? Do you think the US government would really default on its debts? Comment below!
Thanks for a balanced take on the debt limit commotion. I was in DC during the last one (waiting for it to end so I could meet with people in the government) and was struck by the way the stock market actually went up. Investopedia has a nice graph showing the stock market reactions to prior shutdowns and they report a net 0 effect although any analysis like this will miss the price action immediately before shutdowns. For the shutdowns in the past few years government workers were forced to stay home and faced delays in getting paid but were then paid although they weren’t allowed to work. https://www.investopedia.com/news/how-shutdowns-dont-affect-market/
Remember many of those essential public servants were required to work but didn’t get paid IIRC. And whew boy was I mad at our congress critter who complained that she wouldn’t get her $170K/year (with an employed lawyer husband) for those weeks instead of working hard to make sure her <$50K/yr average constituents didn't suffer too long.
The federal employees who have to work during a shutdown get paid after the shutdown. In the vast majority of cases, the federal employees who don’t work during the shutdown get paid after the shutdown.
The only exception I can think of was furloughed federal employees during Ted Cruz’s shutdown back during the Obama presidency. Even then, folks missed out on maybe three days of pay (but didn’t have to work).
Yet another good reason to have an emergency fund though.
Brilliant summary!
I read a recent article (source below) on the debt limit issue that referenced the 14th Amendment of the U.S. Constitution, Section 4, states: “The validity of the public debt of the United States, authorized by law, including debts incurred for payment of pensions and bounties for services in suppressing insurrection or rebellion, shall not be questioned.”
The Executive branch could choose to ignore the debt limit “crisis” and challenge the Republican House to take it to court. Albeit, if the conservative Supreme Court ultimately ruled that spending approved in prior Congressional budgets could later be rejected when it came time to pay the bills then we would really have a crisis.
As WCI alludes to above, the time to deal with overspending issues is not after you get the bills for expenses that were previously authorized in a congressional budget signed into law.
Source reference: CNN What Matters newsletter, dated 2/1/2023, “A simple way Biden could stop this drama and ignore the debt limit.”
For years this has been much to do about nothing. However, with the new batch of extremist in Washington, it’s hard to predict what they will do. After January 6th, it’s more and more obvious that what’s in the best interest of the country isn’t always at the forefront.
The funny thing is republicans in the house are threatening to do this when it was a bipartisan approval of this budget. Plus, it’s always convenient that Republicans complain democrats spend too much yet are okay with spending when they are the ones in power. Frankly, they are both the cause of the debt issues. I read an article said that the debt limit itself is dumb and they should get rid of it all together. Especially rings true when they have to increase it every time anyways to prevent shutdown so there’s no point of it other than political posturing. It would be nice to see the government spend less than they bring in one in a while though.
Keep in mind that “bipartisan” can mean that 1 Republican and 220 Democrats voted for something. Can’t be too surprised when the other 200 Republicans are still upset about it.
That is true but on this case, if I remember correctly, it was many more than that. Although in the house it was not as many percentage-wise as in the senate. And I guess I don’t care enough to look it up. Ha.
At least in the case of the screaming couple, they have the risk of having their house and car repo’d and bankruptcy and all that. This is not in the case of the US govt. The US govt can always pay its loans. After all it’s the sole issuer of the currency. So it’s like the couple have 10K debt in monopoly money, they scream at each other, and then they write themselves new monopoly money.
I also like the idea that democrats and republicans are like a bickering old couple. There is a lot of truth to this. They are, at their core, very similar parties.
There are consequences, primarily that it costs more to borrow money in the future.
Do you mean because of inflation?
No, simply that lenders/treasury buyers demand higher rates when the possibility of default goes up .
I think we’re saying the same thing? Like you say in the article, for the federal govt, the possibility of default is an arbitrary, self imposed possibility. They can always issue new dollars to pay back any loans with interest. The only real constraint is inflation, i.e., whether the money they are pumping into the economy actually has any demand.
I’d be careful with that “always” stance. Things can always happen until they don’t. According to Lehman Brothers, Americans generally “always” payed their mortgages, until they didn’t. Enron was always able to roll it’s commercial paper until it wasn’t.
It’s not correct to conflate the debt ceiling with past government shutdowns. Shutdowns occur when annual appropriations bills aren’t passed in time, and as Dr. Dahle notes, have occurred a number of times in recent decades.
But we have never previously failed to raise the debt ceiling before extraordinary measures ran out. The risk is much greater than with shutdowns, because it could result in a default on government debt payments. No one knows for sure (there are other options, ranging from prioritizing some obligations, to ignoring the limit, or trying to avoid it with higher interest rate debt that has lower face values or with gimmicks like a trillion dollar platinum coin). But a default is possible, which is not the case with shutdowns.
The ultimate point is that there is much greater uncertainty (and potential risk) with the debt ceiling than with prior government shutdowns. See this article for a further explanation: https://www.reuters.com/world/us/shutdown-default-washingtons-risky-new-debt-ceiling-standoff-2023-01-24/
That’s a good point. Not only is a shutdown threatened, but also a default, but the shutdowns we’ve had were all caused by a failure to pass an appropriations bill (or usually another stopgap continuing resolution.) So far they’ve been separate–debt limit crisis/threats to not raise the debt ceiling and shutdowns.
A lot of people and commenters here tend to get all political about this issue, but try to think about it dispassionately.
#1 We all know they’re not really going to default on the treasury payments. And if they do force that, they’ll quickly fold shortly after. All theatre and noise, but doesn’t matter.
#2 The treasury general account (TGA) at the Fed will be drained during the extraordinary measures, which will increase money supply (M2) and end up mostly in overnight reverse repo funds (ON RRP) and to a lesser extent in Fed reserves. This, more so Fed reserves than ON RRP, will basically offset the $95B in tightening the Fed is doing every month. In other words, this is good for equities. The actual showdown won’t be until September/October, which is when all extraordinary measures will exhaust. When a deal is made and the TGA is rapidly built up, stocks will drop after this due to M2 contraction (Q4) – something to keep in mind while this is all going on. People are going to be like “great! a deal was made, now stocks can go through the roof!” But will actually be the opposite largely due to the TGA.
#3 no country that can print its own money ever “defaults” in the sense they don’t pay their debts. That would be the right thing to do, and stop governing with debt, but will never happen. Instead, the government defaults a little bit more every dollar it prints. We are closely approaching the point where interest on the $31 trillion in debt will consume the entire amount of tax revenue brought in, at which point we have basically defaulted. This will be accelerated if interest rates continue to rise.
We are not closely approaching that point. It’s at 14.29% right now. Lots more than it used to be.
Good point. A bit of hyperbole on my part – 14% isn’t good, but doesn’t sound that bad.
On the other hand, rising interest rates can jack up this number very quickly. The average rate of the federal debt right now is 1.4%, but as it matures is being re-issued at auction anywhere from 4.6% on 1 month notes to 3.7% on 30 year notes. The average time to maturity on existing debt is 5-6 years, so a significant chuck of debt is getting refinanced at a 3x higher rate every month, every year.
And treasury yields have a lot of room to run higher. All maturity lengths are currently below the Fed overnight funds rate, which they normally shouldn’t be. Yields could easily rise to 5-7% by next year if the fed truly holds rates steady near 5% as they say they will and the yield curve steepens (un-inverts).
And if inflation proves stickier than many people expect ala the 70’s/early 80’s, then we could even see the Fed raise rates further and keep them there for years. The 10 year treasury peaked at over 15% in the early 80’s. Imagine even getting to 10% yields – that’s 7.1x the current average yield. If the average rate on treasuries gets to 10%, that would put us over 100% of tax receipts going towards interest payments. (7.1 x 14.29% = 101%). And that’s assuming the debt doesn’t increase relative to tax receipts! That’s an extreme example, but imagine the pain just from from being stuck at 6% yields for a few years. That alone could get us to 50% of taxes going to interest.
The only other option is cut rates back to 0% and do monetary easing, which will stoke inflation – and start the cycle all over again, but starting in a far worse position.
I’m actually alarmed it is 14%. I swear it was 7% the last time I looked. But I knew it wasn’t anywhere near 100%.
I wouldn’t go so far as to argue that the national debt is not of concern and it is obviously trending in the wrong direction, but we always couch this in terms of debt-to-GDP or debt-to-tax receipts (basically a debt-to-income ratio for the US government). What about a debt-to-net worth ratio? In personal finance, if you owe more than your income, that’s generally bad, but if your net worth is already 10x what you owe, then who cares? The net worth of US government has got to be in the hundreds of trillions, right?
I’ll confess to not knowing a ton about this level macroeconomics, so maybe that’s a silly or irrelevant point, but I feel like it never comes up in national debt discussions…
what are we going to do, sell off Andrews Air Force Base or Denali National Park and make a payment on the debt? Not sure the government’s net worth matters much. Most of America is owned privately. Although there is a lot of federal land out West….
Haha, exactly! Why stop there?! Sell the whole of Alaska back to Russia (I’ll bet the ROI would be great when its all said and done). And while you’re at it sell those $2 trillion of student loans to private creditors, and NASA to SpaceX, and USPS to FedEx. We could be back to broke in no time…
Alright, I’ll agree that isn’t the least little bit practicable and probably should be irrelevant to policy decisions. But its gotta mean something, right? If you’re gonna run debt 120% of GDP, you’re probably in a lot better shape than you think with 10x assets behind that debt.
Even if it works, that’s a 1 time fix. The US government has shown it’s no longer capable of being fiscally responsible, and needs to be forced to be. Something like a balanced budget constitutional amendment might work. Then again, the constitution requires a declaration of war by congress before making acts of war, but they never follow that anymore, so good luck…
Well the thing is that we don’t need an absolutely balanced budget. Public debt is okay and probably beneficial. (Ask Alexander Hamilton for details.) But nobody can agree on how much is okay and how much is not.
I’m sure that’s true, but I can relate more to Andrew Jackson’s sentiments. The problem is, you give a mouse a cookie…
Jefferson was wrong on this point, as were the later adopters of his ideas like Jackson. But that doesn’t mean the debt should be unlimited.
One key difference between a personal DTI ratio and government interest payments as a % of tax receipts is that DTI implies a portion is going to principle, but we’re just talking interest only here.
Another key difference is that the rate the government pays can change at any time and is out of anyone’s control (to some extent the Fed can control it, but that’s not one of their mandates – they have enough to worry about already). In the current situation, the government is forced to slowly refinance the current debt at TRIPLE the rate as it matures. And this could go much higher yet, plus the longer rates remain elevated, the more debt matures into these elevated rates.
We have financial problems in this country. I have summarized some of the problems but conclude that while SS has problems, it should not be used to help get the budget under control
https://shawnpheneghan.wordpress.com/2023/02/15/straight-talk-on-social-security/
Fixing SS is an order of magnitude easier than fixing Medicare. 4 or 5 little tweaks to spread the pain and it’s fixed:
Raise benefit age to 64-72 instead of 62-70
Charge tax on $200K instead of $144K
Make it 85% taxable to everyone
Put a cap of 5% on inflation adjustments
Increase the tax to 12.6% instead of 12.4%
You know, some combination of those sorts of things and it’s good to go. Which ones get done would be a big political battle, but better to have it sooner than later.
No idea how to fix Medicare without fixing the health care system which is a massive problem.
Re: fixing healthcare.
Tax high sugar/carbohydrate foods, sodas, candy, baked goods except bread, tobacco (more), alcohol (more). Worked for smoking in Hawaii.
Take corn/grain farming subsidies and funnel them towards local growers of fresh fruits and vegetables (higher micronutrient content per calorie and less calorically dense). Cheap calories aren’t what the U.S. is in dire need of.
Take taxes from the aforementioned products and fund medicare/caid with an emphasis on prevention and primary care. Funds come from vices or health damaging products and go toward the most vulnerable.
Let consumers shop across state lines for insurance, competition is a good thing.
Inculcate the idea that medical insurance should be used like car insurance, in dire situations, and decouple it from your job. Cash for the majority of things. Can you imagine justifying to State Farm that they should negotiate a cheaper oil change for you, but only certain places, and also only after you’ve spent $500 on your car’s maintenance? Let me take cash or card, remove a whole slew of administrative staff (and overhead), and slash the need for death-by-documentation to appease the parsimonious bean counters at BCBS?
Increase federal funding of residency positions
Require that all EMRs that process payments from government payors have functional compatibility between systems, reducing waste and time. “Mrs. Jones, when was your last cardiac cath? What did your last back MRI show? Can you tell me your A1c from the last 12 months?” *In the ER to a somnolent patient* “Can you tell me what meds you’ve been prescribed or your medical history?”
I think that’s a start