By now, you have probably been hearing a lot about the debt ceiling. Democrats and Republicans are arguing about how to resolve the issue and it seems likely to remain a contentious matter for much of this year. But what is the debt ceiling and why is it important? Here’s a quick refresher on the topic.
The debt ceiling, also known as the statutory limit on government debt, is a legislative limit set by Congress on the amount of debt the federal government is allowed to accumulate. The debt ceiling acts as a cap on the total amount of debt that the federal government can legally borrow to finance its spending and obligations.
The debt ceiling has been in place since 1917, when Congress passed the Second Liberty Bond Act, and refined further in the 1930s. The limit applies to all federal debt, both the debt held by the public and the debt held in the government’s own accounts such as the Social Security Trust Fund. It has been raised numerous times over the decades to accommodate the growing nation and its debt. The debt ceiling is not to be confused with the federal budget, which outlines the government’s revenue and spending. The ceiling sets a limit on the government’s ability to borrow to finance its various activities.
Why is the debt ceiling important? If the U.S. Treasury is not able to issue more debt to finance its operations, it would be forced to either not fund Congressionally-authorized spending or default on existing debt that comes due. Never in the history of this country has the U.S. defaulted on its debt. Given the massive size of the Treasury bond market and their widespread use by all types of investors, a default would be a catastrophic event. The threat of default during the 2011 stand-off over the issue led to a downgrade by S&P of the debt rating of the U.S. to AA+ and also led to a 17% decline in the S&P 500 in the surrounding weeks.
The debt ceiling has been a source of political controversy and negotiation in recent decades. When the federal debt approaches the statutory limit, the Treasury Department may use extraordinary measures to temporarily avoid default, such as delaying investment in federal pension plans or temporarily halting the issuance of new debt.
In recent years, debates over raising the debt ceiling have often been tied to larger political disagreements over spending and taxation. While this piece is not the place to detail the current stance of each major political party, there are plenty of reliable sources to fill your nights with hours of pleasure reading.
With regards to its impact on the financial markets, we believe an agreement will be reached since leaders of both parties have already stated they do not intend to sully the reputation of the U.S., and no one wants to be responsible for a global financial calamity. The extraordinary measures noted above are thought to provide a number of months of flexibility, but there is a point at which these measures would be exhausted (referred to as the “X date”). Many experts seem to put the X date between September and November, but there are many variables at play. The other aspect giving us confidence that a crisis will be avoided is the very fact that markets have seen this before and a resolution is always found.
We hope this brief synopsis of the debt ceiling answers any questions you may have, but please feel free to reach out to your portfolio manager should you need any more information.
Important Disclosures
Maple Capital Management, Inc. (MCM) is an independent SEC Registered Investment Advisor with offices in Montpelier, Vermont and Atlanta, Georgia.
This commentary reflects the views of MCM and should not be considered to be investment or financial advice. MCM does not warranty these views and will not update this communication after the date of publication. Any mention of specific securities is done for illustrative purposes and the securities mentioned may or may not be held in client accounts. No assumption or assurance should be taken that securities mentioned will be safe or profitable investments.
For further information, please contact Steven Killoran at 1-802-229-2838 or at [email protected]. For further information about Maple Capital, including a copy of our informational brochure, please visit our website at www.maplecapital.com.
