The Debt-Ceiling Debate

Liz Laprade:

The debate on whether to lift the debt-ceiling or not has returned to Congress as the US hit its borrowing limit about a month ago. So, what is the most likely outcome? And what happens if the U.S. defaults on its debt for the first time in history?

Hi, I’m Liz Laprade, Senior Research Analyst with Today’s Adviser Takeaway.

The U.S. government has a cap on how much it can borrow from lenders and that’s what we call the debt-ceiling. We hit that limit about a month ago and when this happens, it’s up to Congress to basically raise the limit to allow the government to continue borrowing.

Sometimes, that’s an easy decision and the cap is raised immediately. Other times, like now, Congress is divided between either just simply raising rates or raising rates as long as there are spending cuts passed as well.

So what does this mean for Treasury investors in regards to both what’s happening today and what could happen?

Right now, the Treasury has initiated what’s called ‘extraordinary measures’ to continue making its interest payments. Basically, the government is shifting funds around to free up cash to make those payments. However, these provisions obviously will not last forever and at some point, once we run out of these provisions.

If the limit is not lifted, the U.S. would default on its debt. And that would mean it is no longer going to be able to make interest payments on its Treasury bonds, pay Social Security or pay military salaries and more. And if that happens, the effects on the financial markets and the economy would be much further reaching than just isolated Treasury investors.

So will this happen? Will the U.S. default on its debt? Well, I don’t think so. We have been here before where Congress is at odds. However, while they sort of duke it out, they have issued temporary lifts to the cap to avoid default until a decision is made.

I don’t think that either Democrats or Republicans want to be on the hook pushing the U.S. into default and possibly then an economic crisis. I do think though, the longer the stalemate without any raise, the more likely bond investors get spooked, and we could see some selling over there.

We’ll know more as time goes on. The provisions aren’t estimated to run out until early this summer, so hopefully we get a decision on raising before then.

And that is it for me today. I will talk to you all next week.