The history of the U.S. debt ceiling and potential default is a complex and significant aspect of the country’s financial and political landscape. Here’s a summary of its history:
1. Origins and Early Years:
- The United States’ first debt ceiling was established with the Second Liberty Bond Act of 1917, which aimed to finance the country’s involvement in World War I.
- Initially, the debt ceiling was introduced as a means to provide a limit on the total amount of debt the U.S. government could accumulate.
- Over the following decades, Congress regularly raised the debt ceiling to accommodate increasing spending and the financing of wars and economic programs.
2. The 1980s and the Modern Debt Ceiling Era:
- In the early 1980s, the U.S. national debt began to rise rapidly due to tax cuts, increased defense spending, and other factors.
- During this period, lawmakers began using the debt ceiling as a political tool, using it to negotiate budgetary concessions or policy changes.
- The debt ceiling was regularly increased throughout the 1980s and 1990s, often as part of larger budget agreements.
3. Debt Ceiling Crises:
- In recent years, the U.S. has faced several debt ceiling crises, leading to significant debates and concerns about potential default.
- In 2011, a contentious battle over raising the debt ceiling led to Standard & Poor’s downgrading the U.S. credit rating from AAA to AA+.
- In 2013, the debt ceiling was temporarily suspended through the Bipartisan Budget Act, which allowed the Treasury to borrow without limit until a specified date.
- In 2017, the debt ceiling was reinstated, and the Treasury employed “extraordinary measures” to meet financial obligations until Congress raised the limit.
- In 2019, a bipartisan agreement suspended the debt ceiling until July 2021.
- In 2021, a bipartisan agreement raised the debt limit by $2.5 trillion to a total of $31.4 trillion.
4. Potential Default:
- If the debt ceiling is not raised or temporarily suspended, the U.S. government may face the risk of default.
- Default would occur if the Treasury cannot meet its financial obligations, such as paying interest on existing debt or making other necessary payments.
- A default by the U.S. government would have severe consequences for the economy, including higher borrowing costs, market instability, and a loss of confidence in U.S. Treasury securities.
How could markets react in the three possible scenarios related to the debt ceiling?
The reaction of the stock market to a debt ceiling compromise can vary depending on several factors, including the specific terms of the compromise, market sentiment, and the overall economic conditions at the time. Here are some potential scenarios and their possible market reactions:
1. Positive Resolution and Avoidance of Default:
- If a debt ceiling compromise is reached well in advance of the deadline and assures investors that the U.S. will not default on its obligations, it can provide relief and stability to the stock market.
- In this case, the market may respond positively, with increased investor confidence, leading to a potential rally in stock prices.
- The avoidance of default reduces the risk of market disruptions and can support a favorable environment for businesses and investors.
2. Last-Minute Compromise and Uncertainty:
- If a debt ceiling compromise is reached at the eleventh hour or after significant uncertainty, it may lead to market volatility.
- Investors tend to dislike uncertainty, and a drawn-out negotiation process can create anxiety and potential sell-offs in the stock market.
- However, once a compromise is reached, even if it’s late, can still provide relief and prevent a default. The market may stabilize and regain confidence over time.
3. Unsatisfactory Compromise or Continuing Political Gridlock:
- If the debt ceiling compromise is seen as insufficient or fails to address underlying fiscal concerns, it could lead to market skepticism and negative reactions.
- Investors may view the compromise as a temporary solution that only postpones addressing the fundamental issues, potentially leading to long-term concerns about fiscal stability.
- In such cases, the stock market may react negatively, with declines in stock prices and increased volatility as investors reassess their risk appetite.
It’s important to remember that the stock market’s reaction to debt ceiling compromises is influenced by various factors, including broader economic indicators, geopolitical events, and investor sentiment. While historical patterns can provide some insights, market reactions are inherently unpredictable and can vary in each instance.
Analysts at Deutsche Bank put a 2% possibility the U.S. government will default on its loans, despite days of failed negotiations. Steven Zeng and Brett Ryan wrote in an analyst note Tuesday that an outright default is the least likely of the possible outcomes. (https://www.investopedia.com/debt-ceiling-default-unlikely-7501717)
They put a 45% chance that lawmakers will come to a resolution before June 1st. They also put an equal chance that they will kick the can down the road and extend the debt ceiling through September. This would give law makers time to come to a more permanent agreement on spending.
Steven and Brett also put an 8% chance that the President ignores the debt limit under the 14th Amendment, which sates that the “validity of the public debt of the United States…shall not be questioned.” https://constitution.congress.gov/browse/amendment-14/section-4/
Please keep in mind when you read the above that there have been three similar standoffs in the last 40 years, all of which ended without a default.
I believe they will continue to kick the can down the road. The one consideration I think everyone should look at is the level of debt we have as a country and how we eventually begin to correct that issue. I don’t have the answers, but it could come down to raising taxes, means testing social security, etc. We have engaged in numerous discussions and commenced planning for the diversification of your retirement income sources. Several of you have taken some steps with Roth conversions and saving money in taxable accounts (taxed as long term and short-term capital gains). If anything, this debt ceiling fight brings to light many of the conversations we have had in the past. For many of you we are planning on your retirement being 30+ years and I would think we will have many changes in that 30-year period.
It’s important to note that the information provided here is based on the historical context only and I am simply looking at the historical patterns of the debt ceiling in the past.
Philip Lockwood | Founder + Managing Partner
Address: 3100 Ingersoll Ave. Des Moines, IA 50312
Website: Lockwood Financial Strategies
Securities offered through Parkland Securities, LLC, member FINRA (FINRA.org) and SIPC (SIPC.org). Investment Advisory services offered through SPC, a Registered Investment Advisor. Lockwood Financial Strategies, LLC is independent of Parkland Securities, LLC and SPC
Securities offered through Parkland Securities, LLC, member FINRA/SIPC.