Kicking the Default Can
As the debt ceiling deadline approaches, concerns about a potential government shutdown and even a possible U.S. government default are on the rise. But is the sky really about to fall? History might tell us otherwise. Let’s take a quick look at the history of debt ceilings, explore the possible effects of a shutdown and/or default on the economy, and highlight the creative ways the government has managed to avoid all the worst-case scenarios in the past.
Bad Debt (Ceilings) History
The concept of a debt ceiling dates back to 1917 when the US Congress established a limit on the amount of debt the federal government could accumulate. Before then, it was even worse—in a way. The government had to agree on issuing bonds for every major need. Imagine what an impasse that would be today. Anyway, since 1917, the debt ceiling has been raised numerous times to accommodate the growing needs of the nation.1 While raising the debt ceiling has become a routine legislative action, it has also been a source of political contention, with lawmakers using it as leverage to negotiate budgetary and policy changes. And that’s exactly what “saves” us from most government shutdowns and actual default.2
The Sky is Falling Scenario
A government shutdown occurs when Congress fails to pass appropriations bills, leading to a temporary halt in non-essential government services. This can result in furloughs for federal employees, delays in processing government benefits, and disruptions to various public services. While a shutdown can be disruptive, its economic impact is generally short-lived and reversible once the government resumes operations. This is basically what happened in 2019.
A default, on the other hand, would have more severe consequences. If the U.S. government were to default on its debt obligations, it could trigger more far-reaching financial consequences. This might include a loss of confidence in the nation’s creditworthiness, leading to higher borrowing costs, reduced investment, and potentially slower economic growth.3
Creatives in the Government?
Despite the risks associated with government shutdowns and defaults, history has shown that the US government is at its most creative when faced with these challenges. Lawmakers have often found last-minute solutions to raise the debt ceiling and avert a crisis. For instance, in 2011, the Budget Control Act was passed just hours before the deadline, raising the debt ceiling and implementing spending cuts to reduce the deficit.4 The U.S. Treasury has even employed “extraordinary measures” to buy time and avoid default. These measures include suspending the issuance of certain types of debt, redeeming existing debt, and shifting funds between accounts. While these tactics are temporary, they have successfully prevented defaults in the past.
Let’s not forget that the election cycle—like it or not—has apparently already started. The motivation to agree on yet another raising of the debt ceiling should lead to a complex creative solution.
The Takeaway
We recently started on our fifth decade in business and have yet to see any debt ceiling crisis result in an actual default. Yes, we have seen our share of partial and temporary government shutdowns, and that could be the most likely scenario this time around as well. But our specialty is focusing on how to navigate volatility in the marketplace, and we do it in several ways. We invest using a long-term strategy, we advise clients to keep adequate cash accounts so they don’t sell great companies before they should, and we pay constant attention to the economy, markets, and portfolio companies in order to control investments as well as we can.
So, as the debt ceiling deadline looms, it’s essential to be aware of the potential consequences of a government shutdown, or the unlikely scenario of a default. As family wealth advisors, this situation definitely has our attention. However, history has demonstrated that even the most unlikely “creatives” on Capitol Hill are capable of negotiating a way—almost certainly at the eleventh hour—to kick the nation’s debt can down the road. We shall see.
Sources:
1 https://bgrdc.com/history-of-debt-limit-and-why-it-matters/
2 https://en.wikipedia.org/wiki/History_of_the_United_States_debt_ceiling
3 https://www.whitehouse.gov/cea/written-materials/2023/05/03/debt-ceiling-scenarios/
4 https://sgp.fas.org/crs/misc/R41965.pdf
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