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Debt Ceilings, Sequesters & Shutdowns, Oh My!

BLOG, MARKETS & ECONOMICS, MOST RECENT  |  1 Nov 2013

Well, the U.S. has avoided a dreaded default on its obligations due to the debt ceiling limitation. But, for how long will the relative calm last? The good news is that the government shutdown is over for now and Social Security checks will continue to go out. Also Panda Cam which was a victim of the government shutdown is back online. The bad news is that we will likely face the same battle again in just a couple of months since the debt ceiling fix was only a postponement into early 2014.

Panda

The U.S. National Zoo’s Panda Camera is back online after the government shutdown. The Panda Cam is a live camera of Giant Panda Mei Xiang and her 2 month-old cub at the National Zoo.

What Exactly is a Debt Ceiling?

So what exactly is a “debt ceiling”? Cullen Roche from the excellent site Pragmatic Capitalism does a fantastic job of summarizing what the debt ceiling is:

  1. The United States has run budget deficits for most of its existence.  This means the country spends more than it takes in and so it sells bonds to cover the difference.  This debt they sell contributes to the overall national debt.
  2. In 1917 the US government imposed a “debt ceiling”.  The debt ceiling is a restrictive limit on the amount of debt the US government can have in total.  So, if the US government adds $10 in debt in year 1 and then they implement a debt ceiling of $19 for year two then the national debt can’t expand by more than $9 in year two without raising the debt ceiling.
  3. Going over the debt ceiling would mean the US government legally can’t issue new bonds.  They can reduce expenses (close national parks, etc.) but eventually would be unable to pay maturing bonds and/or interest.  This would be a default which would be catastrophic in ways that would make Lehman Bros look like a walk in the park.
  4. What’s strange about the debt ceiling is that it is not really a constraint on the size of the annual deficit.  That is, spending is appropriated BEFORE the fact and causes the debt levels to approach and perhaps breach the debt ceiling AFTER the fact.  I’ve compared the debt ceiling to eating a pizza and then tying your small intestine in a knot and threatening your stomach not to digest the pizza.  It seems like a rather silly way to go on a diet, right? Anyhow, the government has untied the knot (raised the limit) 79 times since the debt ceiling was implemented.
  5. The USA is one of a handful of countries with such a limit.  Almost every other country in the world relies on the standard political debate process to agree on the proper size of government spending and taxation.
  6. The merits of the debt ceiling are hotly debated.  Is it a useful way to try to control government spending and spark debate?  Whatever the merits of the debt ceiling, the major problem is that we seem to elect people with extreme positions and agendas.  Compromise seems to require us to suffer pain before they reach unsatisfactory conclusions.  This seems to require playing Russian Roulette with the credit of the US government from time to time. Holding ourselves hostage under this self-imposed rule shouldn’t be a necessary part of the political process and it’s a rather dangerous way to get things done.  After all, if we have to default on ourselves in order to cut spending then something much bigger is broken than the levels of government spending….http://pragcap.com/what-is-the-debt-ceiling-and-why-does-it-matter

What effect is the Government Shutdown/Debt Ceiling showdown going to have?

1. According to some estimates, is likely to reduce 4th quarter projected growth from 3% to 2.4%. In dollars this equates to about $24 billion out of the U.S. economy.

2. This was the 79th time the debt ceiling has been raised since its implementation in 1917.

3. It has likely pushed back the planned “tapering” of bond purchases by the Federal Reserve until sometime in 2014, thus interest rates are likely to remain relatively low for the time being.

4. The stock market was only mildly bothered by the government impasse and was actually up during the government shutdown:

S & P 500

Performance of the S & P 500 during the Government Shutdown

5. Hundreds of thousands of federal workers went without pay for a couple of weeks. Although most will receive back pay under terms of the agreement. National Parks were closed, and government contractors weren’t paid.

6. The Republican Party approval rating sank to abysmal levels. The 2014 elections may be very interesting.

Why did the Government Shutdown?

Congress is required by the Constitution to pass spending bills to fund the government. Since Congress couldn’t agree on a spending bill many functions of the government were not funded and had to shut down. This included agencies such as the IRS, the agencies that handle passport requests, government sponsored mortgage agencies and many other parts of the government. Essential services such as the military, Social Security, Air Traffic Control, etc. continued to be funded. Of course, the President and members of Congress continued to receive paychecks during the shutdown. But, don’t you think they earned them?

What is Next & When?

The agreement reached is temporary and a long-term budget deal looks to be very difficult to accomplish. There is a good chance that we will face the same situation again early in 2014, since we will reach the debt limit again in the first couple of months of the New Year. Here are some key dates that will soon be approaching:

December 13, 2013: A bipartisan, bicameral committee must forge a longer-term budget blueprint that includes spending and revenue targets by this date.  Given that the underlying disagreements between the two parties on budget issues that led to this crisis haven’t changed, it’s difficult to see how this committee will be successful.

January 15, 2014: Government funding runs out. If Congress doesn’t come up with another extension, the government could shut down again.

February 7, 2014: The Treasury’s borrowing authority will be exhausted on this date, and it will again be permitted to use its “extraordinary measures” to prevent the US from defaulting on its debts for a few weeks. But because Treasury sends out tax refunds in February and March, the extraordinary measures probably won’t buy a lot of time.

                                                                                        Source: Schwab.com (Washington Watch)

Have our elected officials learned anything from the fiasco we just witnessed? That remains to be seen, but I don’t think anyone is holding their breath.  The United States still has the most creative and progressive citizens in the world and should be able to continue to make economic progress for some time to come.  We believe that Congress might well push us to the brink again but will eventually compromise sufficiently to allow the economy to grow modestly.  However, if Congress and the President do not strike a reasonable balance between expenditures and taxes our children and grandchildren will probably suffer the consequences.