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Picture of Christopher A. Hopkins, CFA

Christopher A. Hopkins, CFA

Reprising the Debt Ceiling Follies

The debt limit is an archaic relic of World War I that should have been abolished long ago, but lives on and emerges periodically to threaten the US economy like a zombie from The Living Dead. The current cap on Treasury borrowing was reached in January and if not increased before the cash runs out, the US economy could go in the tank.

Perhaps responding to the Hollywood writers’ strike, Congress is screening reruns of its greatest debt ceiling hits, resembling in turn High Noon, The Thing, or Blazing Saddles. And the programming is quickly losing its entertainment value.

Recall that the debt limit has nothing to do with spending. It relates only to America’s willingness to pay the bills it already owes and our desire to maintain a decent national FICO score. Failure would be catastrophic.

Ironically, the debt limit was originally intended to make borrowing easier, not to use as a cudgel. Before 1917, each new bond issue had to be authorized by an act of Congress, an exceedingly inefficient mechanism as America entered the war, so legislators granted the Treasury authority to borrow as needed up to a prescribed limit to finance the war. This ceiling has been routinely increased over 100 times, yet only in recent decades has the existential threat of default been exploited as leverage.

In December 2022, Congress passed an appropriations bill authorizing the Government to spend $6.2 trillion during fiscal 2023. Before the vote, the Congressional Budget Office projected tax revenues of just $4.8 trillion. Members of Congress know the definition of “deficit” and understood that their action required the US Treasury to borrow $1.4 trillion to cover the shortfall.

Congress is hardly new to this enterprise. It has failed to balance the budget in 50 of the past 54 years, each time making a legal and moral commitment to the world that we will pay our bills. Since 2001, Congressional deficits have averaged $1 trillion, requiring the Treasury to issue bonds to plug the gap. Yet every so often, members opt to play Russian Roulette with the full faith and credit of the US by threatening to forbid the Treasury from meeting these obligations.

Perhaps as early as June, Congress may prevent the Treasury from raising the funds that Congress spent last December. If this sounds nonsensical, then you have a clear understanding of the preposterous process that is unique among the world’s major economies.

There is no precedent to guide the Treasury’s response once the “X-date” arrives and the bank account is empty. It could attempt to avert a global crisis by continuing to make interest payments on Government bonds and curtailing all other spending. During the near miss of 2011, Treasury gamed out a break-the-glass contingency plan that would have honored interest payments but halted other Federal spending like Social Security benefits, Federal salaries, Veterans’ benefits, and even utility bills until it had enough cash for one full day’s obligations.

Yet favoring creditors would face legal challenges, and in fact a group of Government employees has already filed suit challenging the debt ceiling as unconstitutional. But if the Treasury missed even a single interest payment, rating agencies like S&P and Moody’s would temporarily downgrade America’s credit rating to “D”, joining, however briefly, Silicon Valley Bank and Bed, Bath & Beyond. Even once the impasse is ended, a permanent downgrade from our current AA+ rating is likely. Recall that we once sported a perfect AAA, until the debt ceiling fiasco of 2011.

An actual default on our obligations of any appreciable duration would thrust the US into a recession and wipe out millions of jobs. But even short of the worst-case outcome, America’s global standing and international confidence in the Dollar will take another hit. As we have discussed previously, the favored status of our currency as the global standard has provided us with unique and valuable benefits whose erosion would impact the wealth and incomes of all Americans. The Dollar’s share of global reserves has already fallen from 73% to 59%. Why would we wish to grease the skids?

The bad debt ceiling movie also masks the deeper issue of Congress’s unwillingness to follow its own rules. It hasn’t passed a budget on time in 27 years, reverting to emergency stopgap funding measures to keep the trains running. In fact, in only 3 of the 46 years since 1977 did Congress did not rely on emergency continuing resolutions, and finally approved the 2023 spending bill 3 months into the fiscal year. Deficit reduction is properly addressed through holding Congress accountable for a functional budget process, not by hostage-taking when the light bill comes due.

Ultimately, nothing focuses the mind quite like a nice stock market crash. It took a 19% drop in the S&P 500 to get a deal in 2011 that produced a 10-year spending reduction agreement called the Budget Control Act. Since then, Congress has routinely ignored those limits and doubled the national debt. All that turmoil to no effect.

Markets are so far betting on a last-second deal, but as midnight approaches volatility will surge. Perhaps the most likely scenario is an emergency suspension of the debt limit until Fall (kick-the-can is a favorite Congressional pastime).

Of course, the responsible reaction would be eliminating the debt ceiling altogether and passing a legitimate budget on time. Don’t you love a good fantasy film?

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