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The debt ceiling is a self-imposed limit on the amount of money the U.S. government is permitted to borrow.
The government does this by selling Treasury bonds, then uses the money to finance interest on previously issued debt and pay salaries and benefits. When the debt ceiling is reached, the U.S. Treasury cannot issue any more debt. It can only pay expenses from collected tax revenues.
This past January, our government reached the debt ceiling limit of $31.4 trillion. After reaching the limit, the U.S. Treasury began to rely on “extraordinary measures” to continue to meet the government’s obligations.
Without an increase, suspension or elimination of the debt ceiling, the government cannot issue more Treasury bonds. Thus the government must make a decision to not pay interest owed and effectively default. In such a scenario, government leaders must choose to prioritize paying debt obligations or delay paying federal employee and retiree wages and benefits.
What would happen if the U.S. defaulted on its debt?
The good news is, it has never happened. The bad news is, it has never happened, so there is no historical precedent.
Given that default is truly an unknown event, the effects are truly uncertain. The possible impacts of a protracted default that isn’t resolved quickly is purely speculative, but impacts could be felt in the following ways:
- A decline in Gross Domestic Product (GDP).
- Government employees, retirees and recipients experience reduced/deferred payments.
- Business spending would decline.
- A sharp rise in rates would have a negative affect on stock prices.
- The dollar would likely drop as investors are less inclined to hold dollar assets.
- Liquidity in markets could be severely impaired.
- Monetary policy would shift to accommodative to re-stimulate growth.
So what should you do with your portfolio? How one responds is going to be a matter of risk tolerance. If you are risk averse, then a few options to consider are:
- Avoid purchasing Treasuries around the X-date or Treasury securities at all, temporarily.
- One-month Treasuries yields are elevated.
- Do not place cash in money market funds.
- Consider using FDIC-limited balances in CDs if you don’t trust the government.
- Don’t recommend selling all equities. Do expect volatility.
- Hold cash and look for opportunities to deploy it opportunistically.
Opportunistic investors might look to take advantage of market price swings:
Looking at prior events such as 2013 when the country was on the verge of default, Treasury yields remained relatively stable and the S&P 500 Index actually rose.
- This might be an opportunity to add to equities and buy from panic sellers.
- Continue to focus on the longer term beyond this event.
- Just keep buying Treasuries as normal.
“Our team of advisors at 1900 Wealth are committed to defining and implementing individual investment plans,” said Todd Brockwell, president of 1900 Wealth. “We know it can be difficult to fully understand the implications of what is occurring within the government and financial markets. That is why we help our clients navigate these situations and provide the best solutions and outcomes for their wealth needs.”
