The story is always the same: we hear that Social Security checks might not go out and how government services will imminently shut down. Party leaders blame each other for the "standoff", the market wobbles for a few days, and the media breathlessly amplifies every minute of it. At the last minute, there is "a deal" that averts catastrophe… for a few months until we do it all over again. There are few financial topics that one could cover that are as recurring, predictable, and spurious as the debate around the federal debt ceiling.
In this article, we will look at the origins of the debt ceiling and discuss its purpose and efficacy as a mechanism for promoting fiscal responsibility, or if it serves another purpose. We will examine these aspects to gain a deeper understanding of the debt ceiling issue, enabling investors to approach this and the inevitable future occurrences with a more informed perspective and reduced anxiety.
A Brief History of the Debt Ceiling
The concept of a debt ceiling emerged in 1917, initially serving to provide the Treasury with greater flexibility in managing government debt during World War I. Before 1939, Congress authorized borrowing for specific purposes or programs, which resulted in multiple limits on different types of debt. This made the federal borrowing process more complicated and less efficient. Congress instituted a single, aggregate limit in 1939, intended to streamline the process and enable it to choose the most cost-effective and efficient borrowing options available at any given time.
The debt ceiling serves as a self-imposed constraint that Congress can modify as it sees fit. It does not control spending directly but limits the Treasury's ability to borrow money to cover expenditures that Congress has already authorized. The debt ceiling was meant to serve as a reminder of the consequences of government spending decisions and underscore the importance of fiscal responsibility.
Congress ought to demonstrate fiscal responsibility and act as careful guardians of the nation's finances. The issue at hand is whether the implementation of an arbitrary debt ceiling, represented by a single cumulative limit on permissible debts, effectively addresses the challenge of curbing excessive government expenditure.
Bluntly, the debt ceiling has never been a deterrent to unsustainable government spending and debt accumulation. Since its inception, the debt ceiling has been raised, extended, or suspended nearly 100 times in less than 100 years and Congress voted for the first increase the very next session after the limit was introduced! Ceiling increases occur with equal frequency regardless of the majority political party. It appears that government spending and disregard for self-imposed limits is a bipartisan effort.
Economic Self-Harm via Political Brinksmanship
Congress has never voted to decrease the limit and has voted to increase or extend it 100% of the time. Despite this history, the effects of failing to increase the debt limit would be serious:
- Government shutdowns: Failure to raise the debt ceiling can lead to a shutdown when the Treasury can no longer cover expenses. This halts government benefit payments and defunds non-essential government services, causing
disruptions and inconveniences for millions of Americans.
- Financial market turmoil: Uncertainty surrounding the debt ceiling causes volatility in financial markets, potentially leading to declining stock prices, increased interest rates, and reduced creditworthiness. The 2011 debt ceiling crisis resulted in the first-ever downgrade of the U.S. credit rating. A government shutdown or potential default can disrupt the global economy, making other countries more cautious about investing in or trading with the U.S.
- Increased borrowing costs: Prolonged debates over the debt ceiling can lead to higher borrowing costs for the U.S. government as investors perceive higher default risks, exacerbating the country's fiscal challenges.
One may rightly wonder: if the risks of failing to increase the limit are so catastrophic, but the outcome of the debate is always the same, why does it seem that are we stuck in an insane cycle of approaching the arbitrary limit and arguing over what to do while the global economy and American lifestyles are held hostage? What is the point of having a debt limit if it is little more than economic self-harm via political brinksmanship?
Lawmakers from both major parties have weaponized the debt ceiling to gain leverage in budget negotiations or force debates on other policy issues. By threatening not to raise the debt ceiling or delaying the process, members of Congress can put pressure on their opponents to make concessions on spending cuts, tax policies, or other legislative priorities. In fact, the debt ceiling is far more relevant as a political bargaining chip than as a a deterrent to debt accumulation and unsustainable fiscal policy. When viewed from the historical perspective, it becomes clear that debt ceiling debates are not anomalies or even uncommon. Rather, these crises are standard operating procedure for the American Congress.
If it was ever seriously intended to be a mechanism to promote fiscal responsibility, the debt ceiling has literally never been effective. Its arbitrary and changeable nature has rendered it meaningless, while its use as a political theater creates the perpetual risk of economic disruption. As debates surrounding the debt ceiling continue, Americans should consider whether this self-imposed constraint is truly serving the best interests of the nation and its economy or if alternative measures would better address the root causes of government overspending. Debating about whether to spend money is good, debating about whether to pay the bill is absurd.
In the meantime, investors have nearly 100 reasons to be optimistic that the current "crisis" will turn out exactly as all previous "crises" have and should maintain the view that debt ceiling debates have little long-term impact on a financial plan.
Frank Hujsa, CFP®, CLU®
Partner, Acadium Financial Partners
Financial Adviser, RJFS
Any opinions are those of Frank Hujsa and are not necessarily those of Raymond James. Securities offered through Raymond James Financial Services, Inc. member FINRA/SIPC. Acadium Financial Partners is not a registered broker/dealer and is independent of Raymond James Financial Services. Investment Advisory Services offered through Raymond James Financial Services Advisors, Inc.
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