What's a debt ceiling?

There's another manufactured crisis upon us...the US treasury is approaching the debt ceiling.

So, what the heck is it? Why do you have to care? Let's dive in...

The Ceiling

The debt ceiling is the term used to describe the agreed-upon maximum debt the country can use before it must stop taking on new debt.

Before we go any further, let's get something out of the way. The concept that our country has a debt ceiling is simply, utterly, ridiculous (count how many times I say ridiculous).

If you're reading this, the country has been in debt your entire life, the debt ceiling concept started in 1939. If you look at the line, it only goes one direction: up.

The USA is one of the only countries in the world with a debt ceiling, and if you study the graph above, you can see why. Most countries recognize it's ridiculous.

So why are you hearing about it? Our silly national politics, of course!

Congress establishes the debt ceiling...then enacts policies to spend more money...and go further in debt. They are putting a stop to laws they've already passed.

The debt then rises to the limit again, which gives our politicians another chance to fake a crisis and pretend only their side can save us.

If you're decidedly one-sided in your political beliefs, you probably read that last paragraph and said 'Yeah if it weren't for those damn (fill in the party you hate) we wouldn't worry about this debt ceiling nonsense.'

The truth is both parties raise it constantly. Just this century (23 years) alone, it's been raised or suspended 24 times.

Is something a crisis if it happens, on average, more than once per year?

So if this is so ridiculous, why should we even care? Glad you asked...

The Real Crisis

Our government debt is considered 'risk-free.' The US government-issued treasury bills, bonds, etc are a foundation of our entire global financial system in that they are considered guaranteed debt. They will always be repaid.

If the debt rises to the debt ceiling limit, technically the Treasury will no longer have the cash to pay its debt, including interest payments on the treasuries.

If the government were to miss its credit payments, now you have a technical 'default' - when a party fails to pay the interest on its debt. This would be a crisis...the US is the cornerstone of the entire world's capital markets, and we would have a global credit scare that would be far-reaching and harmful. We're talking trillions of dollars that would be in flux:

Treasury bills/bonds would instantly become volatile in price, which would spill over into the stock market, and the panic would spread from there.

Not to mention other government obligations, like social security, Medicare, military wages, etc...would all be delayed.

The Council of Economic Advisors estimates a default could lead to a 45% decline in the stock market and a 6% hit to GDP.

Hence, our ridiculous manufactured crisis. Here's why it won't happen...

The Reality Check

First, let's be real: Congress are human beings (pause for laughter). They're also very rich human beings...and they own companies, stocks, and bonds, just like the rest of us. They don't want to lose money any more than you do.

Second, there are many ways to circumvent a crisis that don't involve Congress. Before we would default, you can expect other hail marys from all angles.

Finally, if this actually happened and the market melted down, then the politicians would scramble to enact all sorts of stop-gap measures to calm everyone. And they'd likely do it quickly, so things would probably go back to normal within a few days.

Unfortunately, we are stuck in an environment where even the most boring event can no longer pass without ridiculous political drama.

There won't be a default. Probably not in your lifetime.

This weekend when you're watching the news and you see the 'debt crisis' headline, remember that at any time Congress can raise it to infinity. At any time Congress can reduce their spending. At any time they can simply do away with a debt limit altogether.

The only reason they don't take those actions is it gives them another de facto political crisis made for TV soundbites. Don't fall for it.

Disclaimer: All written content on this site is for information purposes only. Opinions are solely those of Innovate Wealth unless otherwise specified. Material presented is believed to be from reliable sources and no representations are made by our firm as to another parties’ informational accuracy or completeness. All information or ideas provided should be discussed in detail with an advisor, accountant or legal counsel prior to implementation.  

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