Originally published: May 5, 2023 (distributed by Andrews McMeel Syndication)
When the U.S. government spends more than it collects in revenue, it creates a "deficit," which the Treasury Department covers by borrowing money when it issues new debt through government securities, according to U.S. Government Accountability Office (tinyurl.com/2p8prcpj).
There is a limit to what the Treasury can borrow, known as the "debt ceiling" (or "debt limit"), and that's the problem that we're facing today. We reached that limit ($31.4 trillion) on Jan. 19 of this year, according to the Congressional Budget Office (tinyurl.com/ysxwfpw8).
Six days earlier, Treasury Secretary Janet Yellen wrote to congressional leaders (tinyurl.com/4r62asj3) that the Treasury Department "will need to start taking certain extraordinary measures to prevent the United States from defaulting on its obligations."
While it's not possible to predict an exact date, Yellen anticipates that a potential default (the "X-date") might occur next month. On May 1, she told congressional leaders: "[O]ur best estimate is that we will be unable to continue to satisfy all of the government's obligations by early June, and potentially as early as June 1, if Congress does not raise or suspend the debt limit before that time" (tinyurl.com/7aav54vf).
If the debt ceiling is not raised before the X-date, "the government may also have to prioritize its principal and interest payments on Treasury securities to head off a default, and delay payments to U.S. households. That could affect Social Security, military salaries, tax refunds, food stamp benefits and unemployment insurance, among other programs," explained Michael Zesas, head of U.S. Public Policy Research for financial services firm Morgan Stanley (tinyurl.com/mu457a3v).
History tells us that this state of affairs is nothing new. If you look back to the end of World War II, we've lived through 102 modifications of the debt limit, according to the Congressional Research Service (tinyurl.com/me44tsk6) -- even in a contentious year such as 2011. That's the year Standard & Poor's cut its credit rating for U.S. Government debt from AAA to its current rating of AA+. The change in credit rating "unnerved U.S. financial markets for a time, but they quickly recovered," quoting a Capital Group investment insight article (tinyurl.com/4tuznd56).
"I think the lesson from 2011, and a subsequent debt ceiling impasse in 2013, is that these events can disrupt markets for a while -- sometimes even weeks or months -- but if we look at history, they don't tend to have a lasting impact on investors," said Matt Miller, a Capital Group political economist. But, of course, Congress must act.
So here we are. Should we be worried about T-bills becoming worthless? What if the government can't make good on Social Security payments? What if federal employees can't get paid?
Some say a default could have "similar macroeconomic consequences to the Great Recession": a 4% decline in the gross domestic product, nearly 6 million jobs lost and an unemployment rate of 7%. (The Committee for a Responsible Federal Budget, a nonpartisan organization, citing a Moody's Analytics report (tinyurl.com/45h4ea68).)
Others say a default won't occur, pointing to history and the nature of congressional decision-making.
There is hope for a solution soon: "We have discounted the possibility of a prolonged impasse lasting more than a week. The economic damage would be so severe, in terms of higher unemployment and economic recession, that it beggars belief that Congress would not respond," quoting a report by UBS Financial Services (tinyurl.com/3d7ncbra).
Where does all of this put you, the investor?
You'll have to decide the best course of action for yourself, since your situation is unique to you. If you are working with a financial professional, now is the time to make sure you are in sync on how your investments are being managed and how different types of risks are considered.
As for one approach, "Stability and safety have always been, and will continue to be, our top priority in helping Fidelity customers plan for -- and live in -- retirement," said Rita Assaf, vice president of retirement at Fidelity Investments. "To this end, we are engaging with our customers to educate them on the debt ceiling, reinforcing the importance of having a financial plan."
My best advice: Have a realistic risk management plan that takes into account your investment time horizon and anticipates both good and bad markets, including a congressional delay, or even the unthinkable, a potential default.