Close up image of the American Flag for the United States of America

19.05.23

The US Debt Ceiling | May 2023

In this piece, we take a closer look at the US Debt Ceiling and why this matters to financial markets around the globe. Let’s dive in…

Over the past few weeks, financial markets have found themselves forced to worry about the US potentially defaulting on its debt obligations. In light of this, you will no doubt have heard a lot of talk about the US debt ceiling.

 

What is the debt ceiling?  

 

The debt ceiling is the limit on the amount of money the US government can borrow. The limit, which is set by the US Congress, currently stands at USD $31.4 trillion – a figure last set by Congress in December 2021.

 

Graph showing the Statutory Debt Limit and Federal Debt Subject to Limit (Trillions)

Sources: Congressional Research Service, Office of Management and Budget, and Treasury Department

Why does the debt ceiling matter?

 

Because the US runs a significant budget deficit, incoming tax payments do not provide enough income for the government to pay its bills. Without the ability to issue more debt, the US Treasury will run out of money and be unable to pay government salaries and government suppliers, as well as not being able to make interest payments and principal payments on outstanding debt. This is a disastrous scenario.

How did we get to this point and why does the US government even have a debt limit?

 

Prior to the First World War (WWI), the US government did not borrow very much and as Congress controls spending and taxation, they required the US Treasury to come to them for approval every time they wished to issue government debt. WWI made this challenging, as the country needed to raise a great deal of debt to pay for the war. In response to this, Congress provided blanket authority to issue a proscribed amount of debt (about USD $25 billion).

Fast forward to the 1930s when the Treasury asked Congress for more flexibility, so they could refinance the WWI debt and start preparing for the Second World War (WWII). In 1939, Congress set a debt limit of USD $45 billion and by the end of WWII it had risen to USD $300 billion. The debt limit stayed at a reduced level of USD $275 billion until 1962. It has been raised over 80 times since then, usually without drama.

 

Are we currently in a crisis?

 

We could be if Congress and the President do not reach an agreement by early June. The Republican party controls the House of Representatives and passed a bill to raise the debt limit by USD $1.4 trillion through to March 2024, but it requires a sharp reduction in the growth of future spending (not a cut in spending as the President and the Democratic party are claiming).

The Democratic run Senate will not agree to this. Both sides have only begun negotiating despite Treasury Secretary Yellen warning of running out of money by early June. The danger is that both political parties are more interested in point scoring, rather than dealing honestly with the situation, and whether an accident happens.

If the debt limit is not raised or suspended, and the US fails to pay on a maturing treasury security, it would spell disaster for the world’s biggest economy. While the President and the leaders of both parties in Congress understand the risks, a great many members of Congress do not.

We even saw former President Trump calling for risking default to make the Democrats concede on spending. This is an insanely dangerous strategy.

 

What happens if the US defaults?

 

Even if the US manged to pay off a maturing security a few days late, after first defaulting, the likely panic in the markets would be significant. US treasuries are considered the benchmark risk free security and almost all other fixed income securities are influenced by treasury prices. There would be serious doubts about the creditworthiness of the US. If you have defaulted once, well you could certainly do it again.

This would raise the cost of borrowing for the US, perhaps dramatically, and given that the US is running a large fiscal deficit it would be very damaging for the economy. The decline in the equity market would likely be significant.

Nothing good would come from the US defaulting on a treasury security. It must not happen.

 

Will we get a debt limit deal in time?

 

We probably will…after a bit more political grandstanding and some market drama. But this will only be a temporary reprieve unless they abolish the debt limit completely. That does not appear to be on the agenda. We will no doubt face this issue again.

Meanwhile, US fiscal policy is on a dangerous trajectory with the US running large deficits even with the economy growing. This is going to become an issue for financial markets in the next few years and will damage the US dollar and influence the level of US interest rates.

Below is a graph on Deficits taken from the Budget and Economic Outlook (2023 to 2033) by the Congressional Budget Office, which shows the Total and Primary Deficits, as well as Net Interest Outlays. Read the whole report here.

 

Graph showing the Total Deficits, Primary Deficits And Net Interest Outlays

Source: Congressional Budget Office. See www.cbo.gov/publication/59096#data

 

Read more from our Chief Investment Officer Jeff Brummette in our Investment Summary for April 2023. Stay tuned for more insights from Oakglen on the hot topics and latest trends in the financial markets. You can also sign up to our mailing list for more regular communications using the section below.

Jeff Brummette
Chief Investment Officer

Disclaimer

This document is distributed by Oakglen Wealth Limited and / or Oakglen Wealth (Jersey) Limited (hereafter “Oakglen”) to you for your information and discussion only. Unless otherwise stated nothing in this document constitutes investment, legal, accounting, real estate, conveyancing, surveying or tax advice, or a representation that any investment is suitable or appropriate to your individual circumstances, or otherwise constitutes a personal recommendation to you. It is not a solicitation or an offer to buy or sell any security or other financial instrument. Any information including facts, opinions or quotations, may be condensed or summarised and is expressed as of the date of writing. The information may change without notice and Oakglen is under no obligation to ensure that such updates are brought to your attention. The price and value of investments and any income that might accrue could fall or rise or fluctuate. The price of shares and income from them may fall as well as rise and is not guaranteed. You may not get back the amount of your original investment. A change in the economic environment, possible changes in the law and other events may cause future performance to deviate from that expressed or implied in this document. Please note that past performance, simulations and forecasts are not a reliable guide to future returns. If an investment is denominated in a currency other than your base currency, changes in the rate of exchange may have an adverse effect on value, price or income. Investing in Packaged Retail and Insurance-based Investment Products (PRIIPs) carries a high level of risk and may not be suitable for all investors.

Any information provided by a client and used to produce this document will have been checked by Oakglen for plausibility only and the client notified accordingly of any obvious anomalies. This document and any related recommendations or strategies may not be suitable for you; you should ensure that you fully understand the potential risks and rewards and independently determine that it is suitable for you given your objectives, experience, financial resources and any other relevant circumstances. You should consult with such adviser(s) as you consider necessary to assist you in making these determinations. The opportunities and risks associated with each investment product can be found in the relevant underlying securities prospectus and any other supplementary documents. All documents will be made available at any time upon request.

Oakglen does not advise on the tax consequences of investments, and you are advised to contact a tax adviser should you have any questions in this regard. The levels and basis of taxation are dependent on individual circumstances and are subject to change. This document may relate to investments or services of an entity/person outside the United Kingdom, or to other matters which are not regulated by the Financial Conduct Authority, or in respect of which the protections of the Financial Services Compensation Scheme. Further details as to where this may be the case are available on request in respect of this document. Additionally, this document may relate to investments or services of an entity/person outside Jersey, or to other matters which are not regulated by the Jersey Financial Services Commission, or in respect of which the protections of the Jersey Financial Services Commission for retail clients. Further details as to where this may be the case are available on request in respect of this document.

This document has been prepared from sources Oakglen believes to be reliable, but we do not guarantee its accuracy or completeness and do not accept liability for any loss arising from its use. Oakglen reserves the right to remedy any errors that may be present in this document. Oakglen, its affiliates and / or their employees may have a position or holding, or other material interest or effect transactions in any securities mentioned or options thereon, or other investments related thereto and from time to time may add to or dispose of such investments.

This document is intended only for the person to whom it is issued by Oakglen. It may not be reproduced either in whole, or in part, without our written permission. The distribution of this document and the offer and sale of the investment in certain jurisdictions may be forbidden or restricted by law or regulation. This communication does not constitute the solicitation of an offer to purchase or subscribe for any investment or service in any jurisdiction where, or from any person in respect of whom, such a solicitation of an offer is unlawful.

Investments may have no public market or only a restricted secondary market. Where a secondary market exists, it is not possible to predict the price at which investments will trade in the market or whether such market will be liquid or illiquid. As such, for investments not listed or traded on any exchange, pricing information may be more difficult to obtain, and the liquidity of the investments may be adversely affected. A holder may be able to realise value prior to an investment’s maturity date only at a price in an available secondary market. The issuer of the investment may have entered into contracts with third parties to create the indicated returns and/or any applicable capital protection (in part or in full). The investment instrument's retention of value is dependent not only on the development of the value of the underlying asset, but also on the creditworthiness of the Issuer and / or Guarantor (as applicable), which may change over the term of the investment instrument. In the event of default by the issuer and/or Guarantor of the investment, and / or any third party the investment any income derived from such contracts is not guaranteed and you may get back none of, or less than, what was originally invested. Parties other than the Issuer or Guarantor (as appropriate) mentioned in this document (for instance the Lead Manager, Co-structurer, Calculation Agent or Paying Agent) do neither guarantee, repayment of the invested capital nor financial return on the investment product, if nothing is indicated to the contrary. Any capital protection given is usually an inherent part of the product; provided through the use of options, futures or other derivative products. You may have to accept smaller returns on an investment relative to a direct investment in the underlying index, basket, etc. because of the costs involved in providing the capital protection. Such capital protection normally only applies if the investment is held until maturity. The amount of initial capital to be repaid may be geared, which means that a fall in the underlying index or securities may result in a larger reduction in the amount repaid to investors. Alternative investments, derivatives or structured products are complex instruments that typically involve a high degree of risk and are intended for sale only to investors who are capable of understanding and assuming the risks involved. Structured products carry counterparty risk, in that in the event of default by the issuer you may lose some or all of your capital invested even when the product carries capital guarantees. Where this document relates to emerging markets, such investments should be made only by sophisticated investors or experienced professionals, who have independent knowledge of the relevant markets, are able to consider and weigh the various risks presented by such investments and have the financial resources necessary to bear the substantial risk of loss of investment in such investments.

The services described are provided by Oakglen or by its subsidiaries and/or affiliates in accordance with appropriate local legislation and regulation. Certain products and services may not be available in all locations or to all Oakglen clients.

Data Source: Oakglen Wealth (Jersey) Limited and Oakglen Wealth Limited, otherwise specified.

Oakglen is a registered business name of Oakglen Wealth (Jersey) Limited and Oakglen Wealth Limited.

Oakglen Wealth (Jersey) Limited is regulated in Jersey by the Jersey Financial Services Commission for the conduct of Investment Business and is a limited company with company number 121454, incorporated in Jersey on 7 June 2016. Its business address is 4th Floor, 1 IFC, St Helier, Jersey, JE2 3BX.

Oakglen Wealth Limited is authorised and regulated by the Financial Conduct Authority. The registered address of Oakglen Wealth Limited is 30 Golden Square, London, United Kingdom, W1F 9LD and is registered in England and Wales with number 13182724.