Key Takeaways
- The US government is expected to hit the debt ceiling next Thursday, meaning that Congress must approve a raising of the $31.4 trillion limit.
- Treasury Secretary Janet Yellen has written to House Speaker Kevin McCarthy, saying that failure to raise the ceiling could cause “irreparable damage to the US economy.”
- In the past, failure to come to an agreement has caused the government to shut down, including a protracted 35 day standoff surrounding President Trump’s proposed US/Mexico border wall.
The US is hitting its debt limit next Thursday, and Congress has been notified of the fact by Treasury Secretary Janet Yellen. The government running out of credit might seem pretty dramatic, and while it’s not exactly nothing, it’s also a situation that arises on a semi-regular basis.
Even so, Yellen wasn’t mincing words in her letter to House Speaker Kevin McCarthy, stating that “Failure to meet the government’s obligations would cause irreparable harm to the US economy, the livelihoods of all Americans, and global financial stability. I respectfully urge Congress to act promptly to protect the full faith and credit of the United States.”
Usually this type of thing is a bit of a formality for Congress, but these days we can’t necessarily rely on anything going smoothly in Washington D.C.
So what does this debt limit mean and what happens if Congress doesn’t approve an extension?
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What is the statutory debt limit?
The US statutory debt limit is a legal cap set by Congress on the amount of debt that the federal government can accumulate. The debt limit is intended to provide a mechanism for Congress to exert control over the government’s borrowing and to ensure that the government lives within its means.
It’s often described as the national credit card limit, but the reality is a bit more complicated than that.
When the government spends more money than it takes in through tax revenues and other means, it needs to borrow money to make up the difference. The debt limit controls how much the government can borrow to finance its operations. If the government reaches the debt limit, it is not able to borrow any more money until Congress raises the limit.
The practice is designed to keep the government in check, and make them justify their spending to Congress. It’s designed to stop a President and their government going mad and notching huge debts unchecked.
In recent years, raising the debt limit has become a somewhat contentious issue, with some lawmakers arguing that the government should cut spending instead of borrowing more.
It’s important to note that the debt limit does not control government spending, it only controls the amount of debt the government can accumulate to finance that spending.
The government can continue to spend money even if it reaches the debt limit, but it cannot borrow any more money to finance that spending. This can lead to a situation known as a “debt ceiling crisis” where the government can’t pay its bills and default on its debt, causing significant financial and economic consequences.
The current debt limit is set at $31.4 trillion.
Has the limit been hit before?
Yes, the debt limit has been reached multiple times in the past, and the US government has taken various actions to avoid defaulting on its debt.
When the debt limit is reached, the Treasury Department can take “extraordinary measures” to free up additional borrowing room, such as suspending investments in certain government retirement funds. These measures can create additional borrowing room, but they are only temporary and can only be used for a limited period of time.
When the debt limit is reached and these extraordinary measures have been exhausted, the Treasury Department must prioritize the payment of government bills and obligations.
This means that some bills may go unpaid, and the government may default on certain obligations, such as payments to government contractors or interest on the national debt. This can have serious financial and economic consequences.
In 2011 and 2013, the debt limit became a contentious issue and led to a political showdown between the Congress and the White House. This led to a government shutdown in 2013, which lasted for 16 days as the Congress and the White House couldn’t come to an agreement on raising the debt limit. This has caused significant financial market turmoil and stress on the economy.
The government also shut down for four days in January 2018, and the US experienced the longest ever shutdown of 35 days between December 22nd, 2018 to January 25th, 2019. This came as a result of an impasse over President Donald Trump’s proposed spending package for the US-Mexico border wall.
In recent years, the debt limit has been raised on a regular basis with less controversy, but the debt limit issue can still be a potential point of political tension.
What would a shutdown mean for stock markets?
The last thing markets need right now is more bad news. With interest rates on the rise, inflation still high and economic growth sputtering along, many are concerned that there is still worse to come with stock markets.
It’s difficult to predict exactly how the stock market will react to a government shutdown, as it will depend on the specific circumstances and length of the shutdown. A few days isn’t likely to cause many concerns, but a longer period of time could add to the uncertainty surrounding equities.
With that said, Congress isn’t currently facing any particular issues as contentious as Trumps’ wall. With that in mind, it’s unlikely that we’ll see a drawn out shutdown like we say in 2018/19.
How can investors help protect against insecurity?
Right now the markets are like a little kid scared of monsters under the bed. There are consistent frights and bumps that are making them very nervous and jittery, particularly after the terrible experience in 2022.
It means that equities in particular are primed to react strongly to negative news.
It’s why many analysts are predicting volatility to continue, for at least the first half of 2023. So as an investor, what do you do? Sit on the sidelines and wait? You could, but then you risk missing out on the best days when the market starts to turn.
One way to stay in the game while also limiting your downside is to implement hedging strategies. You know ‘Hedge Funds?’ Yeh, that’s where they got their name. They do loads of fancy financial stuff to make sure they always make money, no matter if the markets are down or up.
Sounds complicated? It is. Luckily, there’s an easier way.
Use Q.ai. We’ve packaged up all of this technical financial knowhow into our AI- powered Portfolio Protection, which acts like a hedge fund in your pocket. It puts in place complex strategies like hedging, with zero input from you.
Here’s how it works.
Available on all our Foundation Kits, every week our AI analyzes your portfolio, and assesses its sensitivity to a range of different risks. These are things like interest rate risk, volatility risk and even oil price risk.
It then automatically implements sophisticated hedging strategies to help protect against them. It repeats this process and rebalances the hedging strategies every week, to make sure the plan is always up to date.
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