What is the Debt Ceiling?

The debt ceiling is the legal limit on the total amount of federal debt the government can accrue. The limit applies to the roughly $24.6 trillion of debt held by the public and the roughly $6.8 trillion the government owes itself as a result of borrowing from various government accounts, like the Social Security and Medicare trust funds.

History of the Debt Ceiling

Since the end of World War II, Congress and the President have modified the debt ceiling more than 100 times, according to the Congressional Research Service. In that time frame, the debt limit increased from $300 billion to just under $31.4 trillion.

The US federal budget is on an unsustainable path…but not for the reasons that most people think. The national debt is $31 trillion, much higher than annual GDP, and only going higher, and the budget deficit last year was more than a $1 trillion for the third year in a row. None of this is good.

But the real root of the fiscal problem, and our biggest concern, isn’t the debt or the deficits, it’s government overspending. The debt ceiling debate is about spending, not default or revenue. Revenues are well above trend (see chart). We are spending too much. Having a debt ceiling is important because it makes politicians face the fact that they spend too much. There needs to be a limit.

Ultimately, the government funds itself by borrowing or taxing the wealth produced by private industry. The bottom line is that excessive spending leads to economic problems. According to the Congressional Budget Office, spending on entitlements like Social Security, Medicare, Medicaid, and other health care programs will rise from 10.8% of GDP to 14.9% in the next thirty years. Meaning a 40% increase in entitlement costs.

What we expect is a last-minute budget deal that includes caps on discretionary spending for future years.

But let’s go down the highly unlikely path that the debt limit isn’t raised. The Treasury Department would still have enough cash flow to pay all securitized debt as it came due, as well as entitlements such as Social Security, Medicare, and Medicaid.

The US had a debt problem after the Revolutionary War, which was a small price to pay for starting an independent country. We had a debt problem after World War II, but that was a price we paid to win a crucial war. Our current debt problem is not like those. In too many cases, politicians spend to win favor with constituents.

In other words, the real problem isn’t whether the US raises the debt ceiling right now, it is how the US will pay for all this spending over time.

At some point the US will either reform entitlement programs or raise future taxes to pay for them. Reducing entitlements would help keep more workers in the labor force and more dollars in the private sector, which would help boost future GDP growth. By contrast, higher future taxes would slow down economic growth. Either choice would be unfavorable, but change is necessary.

Our Assessment

While most investors are focusing on the straightforward issue of whether debt payments due this summer gets fully paid, wise investors need to keep their eye on the key long-term issue. That’s what we are watching. Will politicians make progress on limiting future spending? If not, the long-term growth path of the US will continue to slow.

To be clear, we don’t doubt for a minute the government’s ultimate ability to pay its obligations. Our assessment of the minimal credit risk posed by the United States is supported by its strong economic fundamentals, excellent market access and financing flexibility, along with the dollar’s status as a global reserve currency.

We should be prepared for potential market volatility as the deadline for Congress to raise the debt limit approaches. Maintaining discipline can be challenging during extended periods of volatility, but that’s when it’s most important. This bear market has been longer than average. Let’s continue to stick to our plan with a long-term perspective. Reach out if you need anything

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