Over the Cliff?

Last week we explained what the debt ceiling is and how it came into existence. Since then, people have asked what could happen if Congress does not increase it. 

Based on experience, the opinion of most is that in the end, politicians will wait until the last minute to do the right thing and increase the debt ceiling. History shows this is a likely outcome. As the U.S. gets closer when a political standoff may occur over this situation, it is worth reviewing what’s at stake if there’s not a resolution to this recurring problem.

Yes, the Treasury can keep moving money around to pay bills and cover repayment obligations for a while. Eventually, accounting maneuvers won’t be enough to prevent the day reckoning or the debt ceiling “X date.” This is the point of no return when there isn’t any cash available if Congress does not approve additional borrowing. It will be a first if that happens.

The current U.S. debt level is $31.4 trillion dollars. Stacked up in one-dollar bills, this would be the equivalent of almost eight of Chicago’s 110-story Will Tower Building. The last time we had a surplus was 2001. Debt increases because revenue (mostly from taxes) decreases. It’s like individual household budgets. Government spending is greater than income received. Spending includes retirement, disability, healthcare, national defense, Covid stimulus funding, and higher interest charges on the debt itself since interest rates increased. Solutions include raising taxes, spending reductions, and raising the debt ceiling, which last took place in 2011.

Option I

If the political system does not agree on a decision, the U.S. government could issue an executive order based on the 14th Amendment to the Constitution, Section 4, which states that “the validity of the public debt of the United States, authorized by law, including debts incurred for payment of pensions and bounties for services in suppressing insurrection or rebellion, shall not be questioned.” In the absence of an agreement, this alternative could last for many months, or years with a decision by the Supreme Court on the constitutionality of the executive order, ending the recurring issue of the debt ceiling. While waiting, there could be economic consequences. 

Option II 

Unlikely, but worth explaining is the scenario where Congress does not reach an agreement, and then the Supreme Court decides against the executive order. This means that the U.S. falls into a potential technical default. The outcome and consequences would depend on how the U.S. government pays U.S. debts to bondholders, employees, suppliers, and the military. If either of these circumstances occurs, there could potentially be a recession with global repercussions. 

Option III

The only good scenario is what we’ve seen happen every time we reach the cliff or the “X point;” somehow, we get an agreement to increase the debt ceiling limit and move forward. Although discussions typically become emotional as politicians on both sides take advantage of the situation and threaten to send the U.S. and world economy into a very easily avoidable catastrophe, resolution is expected.

According to the Congressional Budget Office (CBO), the “X date” when the U.S. may not be able to pay its bills appears to be August 18 but could be as early as June if April tax revenue runs low. Congress has raised the debt ceiling over one hundred times and avoided shutdowns. It’s likely that this will again be the case. 

Understanding this political hot potato known as the debt ceiling may allow you to sidestep the news media drama and temper the heated debates as politicians posture over this issue. The U.S. runs budget deficits and borrows to pay bills. The last debt ceiling increase occurred in 2021 bringing the limit to $31.381 trillion, which we’ve exceeded. This is an opportunity to address and prioritize spending items while creating a concrete strategy for the future. Plan on increases in perceived risk and financial market volatility as we plot a course and navigate towards a solution for this deadline. In 2021, we teetered on the fiscal cliff before Congress resolved the standoff. At that time, America’s credit rating was lowered for the first me. The debt ceiling increased, and we survived. Stay focused and plan accordingly.