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.
More information here:
Your Crystal Ball Predictions for 2023
Lessons Learned from Trump’s (and Other Presidents’) Tax Returns
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.
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.
More information here:
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.
More information here:
My Favorite Physicians That Became Politicians: The History of Docs in Congress
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!