The Debt Ceiling: What’s really at stake?

The U.S. debt ceiling has been all the chatter in headlines lately. With news outlets leveraging every political angle of the $31.4 trillion (about $97,000 per person in the US) debt story, we have heard countless warnings of a fiscal crisis on the horizon if left unresolved.

The recent announcement from Treasury Secretary, Janet Yellen, informed congressional leaders that the department had begun using extraordinary cash management measures that could stave off default until June 5th.

The debt ceiling – Also known as the debt limit – is described by the U.S. Department of the Treasury as,

“The total amount of money the United States government is authorized to borrow to meet its existing legal obligations, including Social Security and Medicare benefits, military salaries, interest on the national debt, tax refunds, and other payments.”

Looking back, we find that the debt ceiling has been raised approximately 80 times – but when and how did this all start?

Congress birthed the debt ceiling in 1917 through the Second Liberty Bond Act. This act established a statutory debt limit, allowing the Treasury to issue bonds and take on other debt without specific approval from Congress. Before this point, Congress would approve each bond issued by the U.S. Treasury by passing a legislative act. However, public debt had been a concern since long before 1917.

The U.S. has carried debt since its inception, with momentous events such as wars and recessions playing a prominent role in the fluctuating national debt volume. The first debt accumulation was documented in the late 1700s, during the American Revolutionary war.

However, President Andrew Jackson made history in 1835 by paying the national debt in full. An accomplishment that has only occurred once in the history of our country. Fast forward 200 years, and the national debt is hovering at an astonishing level of about $31.4 trillion, relying on “extraordinary measures” to meet the government’s obligations.

As we approach the summer season, we grow closer to default risk – unless the debt limit increases. It is important to note that the U.S. has never defaulted on its obligations; however, even a threat of default could affect the U.S. credit rating and therefore cause drastic swings in the stock market.

Between now and June, we can expect to see demands from members of both political parties, attempting to negotiate a deal in hopes that we do not witness a game-time decision, as we saw 12 years ago. In 2011, Congress increased the ceiling two days shy of when Treasury expected to exhaust its efforts, resulting in a downgrade of the U.S. credit rating – with a strong reaction from risk assets, including a dollar sell-off, sharp decline in stocks, and credit spreads widening. Shortly after, however, we encountered a strong rally in treasuries, which led to higher overall bonds.

2011 aside, the debt ceiling movement has historically produced only short-lived volatility. Our best defense against short-term volatility continues to be diversification, the strategic rebalancing of your portfolio, and planning for liquidity needs.

It is not the first time a debt ceiling crisis has made headlines and struck fear in the U.S. – and it will likely not be the last. We will continue to anchor investment strategies and decisions to your long-term financial planning objectives, considering your short-term needs.