The Debt Ceiling: Why Bother?

By: Aaron Anderson, CFP®, CFA, Managing Partner

May 23, 2023

It seems like we always have something to worry about. Just in the last six months or so, we’ve had midterm elections and big bank failures. Now we have yet another debt ceiling “crisis” on our hands. And like all other reasons to worry, I think it’s just noise when it comes to market performance because the US always pays its bills.

This graph from Visual Capitalist has a lot of information on it so please take a minute to read over it [1].

There are a few things of interest to point out.

The debt ceiling was started in 1917 although it wasn’t in its current form until the late 1930s[2]. Until World War 1, there was usually a specific act of Congress that authorized the expense and the borrowing necessary to pay for it. Knowing the costs of World War 1 in advance to authorize borrowing was not possible so Congress passed the First Liberty Loan Act of 1917 to spend $2B now and allow up to $5B in bonds to be issued when necessary. Note a second act was quickly needed to increase the limit.
The total US debt is more than the annual gross domestic product. This basically means that even if we put the output for the entire US economy toward paying off the debt, we wouldn’t be able to[3]. There is nothing critical about being over this threshold, but it’s a common barometer of the sustainability of a nation’s debt.
The debt ceiling has been raised 78 times since 1970, most of the time with little fanfare. Surprisingly, that means it gets raised more than once a year on average. Sometimes, the debt ceiling was even suspended.
On the left, the graph lists potential consequences. More on those below.

Number 3 lead me to the subtitle of this article – “Why Bother?” – because that was my first thought. Why bother with a debt ceiling at all if Congress is just going raise it every time they need to?

On the one hand, I agree with Republicans in that a debt ceiling at least forces us to take a breath and consider our country’s spending habits. On the other hand, I agree with Democrats in that we have to pay the bills caused by previously approved spending so the budget process is the time to discuss it. That’s as political as I’m going to get!

Maybe the compromise is to include the debt ceiling discussion as part of the annual budgeting process. Coming up with the budget, issuing debt to cover estimated shortfalls, and adjusting the debt ceiling if necessary should all be considered together.

Back to the consequences of everything going on right now. The main issue as I see it would be a loss of confidence in the US as the bedrock of the world economy. As I said before though, the US pays its bills. In financial analysis, we try to decide if the risk of an investment is worth undertaking based on its expected return relative to the “risk-free rate”. The risk-free rate is typically defined as what you can get in US Treasuries based on the time horizon of your investment. Why are US Treasuries considered risk-free with the constant turmoil the country seems to be dealing with? Because the US pays its bills. They are backed by the full faith and credit of the US government which in turn is backed by the hard-working US population and the stable laws that govern them [4].

I believe that is what makes this gamesmanship around the debt ceiling so dangerous. The US will pay its bills, even if a bit late, but what will the psychological damage be to investors and to the world? Will it derail the markets and will it destroy the value of the US dollar?

Obviously, we cannot tell the future for certain, but “past is prologue” as they say so looking at comparable times historically can be beneficial. Because the US is the largest economy in the world and the dollar is the world reserve currency, we cannot look at what happened to other countries that defaulted in recent times since a US default would be in uncharted territory.

So, the best we can do is look at similar times in US history. Despite the talking point that the US has never defaulted on its debt, there are times when it actually has and times when it almost has[2]. We completely defaulted during the War of 1812, we had a technical default in 1933 when President Roosevelt suspended the gold standard, and we were late on a few payments to some small investors in 1979 [5].

One could argue those are ancient history, so let’s look at more recent examples and their effects on the stock market.

1995-1996: For 21 days, the federal government shutdown due to an impasse in budget negotiations and raising the debt ceiling. The market did not seem to react as it continued marching higher until the dot com bust at the end of the decade.
2011: Similar scenario to the one we’re going through today. All sides negotiated an agreement to raise the debt ceiling on July 31, just two days before the deadline. Credit agencies lowered the US credit rating by a notch. That was a rough year for the market with a 19% intra-year drawdown and only a 2% return for the year. But, new highs were reached early in 2012.
2018-2019: Like the mid-1990s, the government shutdown for 35 days making it the longest government shutdown in history [6]. Despite the shutdown, the market recovered during the same time and continued making new highs until the current bear market (ignoring the brief Covid V-shaped recovery). It’s difficult to tell how the market would have reacted to this one in a vacuum because the Federal Reserve had also been trying to tighten monetary policy some at that time and reversed course by lowering interest rates. So, the market had already been in a 19% drawdown when the shutdown happened.

Interestingly, the market reacted differently to each of these; that’s the issue with trying to move in and out of the market around these events. However, the commonality to all of them is that the government eventually paid its bills and the market recovered back to normal.

I am not downplaying the short-term ramifications of this political nonsense that’s going on. The market is already a bit skittish around an expected recession and this doesn’t help matters.

I doubt the government stops paying bond holders and completely defaults, but we could have a technical default where they don’t pay for other things like Social Security, reimbursing doctors and hospitals for Medicare, deferring paychecks to government employees, etc. Government spending is a big part of our economy so this can cause a slowdown if people have less money to spend. In turn, this could hurt expected company revenues and profits and the stock market could take a hit from that.

But, we know over the long term that the market eventually works through all these issues if it doesn’t outright ignore them and I do think that will happen again here.

As a quick addition to the article, I want to try to help you visualize how truly staggering the US debt truly is. Sometimes, you’ll see it written as the tiny “$31T” or the slightly longer “$31 trillion” [7]. As a written-out number, it looks like the longer: $31,000,000,000,000. Large numbers like that are mostly impossible for people to visualize so I lean again on the Visual Capitalist website for an infographic that blew my mind when I first saw it [8].

[1] Source: Charting the Rise of America's Debt Ceiling (visualcapitalist.com)

[2] Source: A History of Debt Limits & Defaults — Investor Amnesia. If you are interested in the history of finance and investments, this website should be on your reading list.

[3] This is a working definition as GDP is a specific number calculated from a specific formula. Please see here for more details: Gross Domestic Product (GDP): Formula and How to Use It (investopedia.com)

[4] One cannot understate the importance of stable laws and regulations when it comes to business. We have the longest standing Constitution in the world, strong private property rights, contracts enforceable by the courts, etc.

[5] A technical default is when payments are still made timely but a different clause in the bond contract is broken – in Roosevelt’s case, suspending the gold standard caused the gold clauses in US bond contracts at the time to be broken and the debt restructured.

[6] Source: 2018–2019 United States federal government shutdown - Wikipedia

[7] Almost $32T according to the unofficial US Debt Clock website. U.S. National Debt Clock : Real Time (usdebtclock.org)

[8] Source: U.S. Debt: Visualizing the $31.4 Trillion Owed in 2023 (visualcapitalist.com)

Content in this material is for informational purposes only and not intended to provide specific advice for recommendations for any individual. All performance referenced is historical and is no guarantee future results. All indices are unmanaged and may not be invested into directly.

The economic forecasts set forth may not develop as predicted and there can be no guarantee that strategies promoted will be successful.