February 3, 2023 – We all learned in high school civics that Congress has the “power of the purse” in our democratic republic. Congress, and Congress alone, passes annual spending plans and other bills that obligate the government to spend money. Just a month ago, President Biden signed a 1.7 billion dollar spending plan that passed both houses of Congress just days earlier. Included in the bill was disaster aid and emergency assistance to Ukraine and NATO, while the bulk of the money went to nondefense discretionary programs (Social Security and Medicare as examples) and to defense spending.
At the same time Congress, and Congress alone, passes tax legislation. No other branch of government can determine what gets taxed, at what levels, and what qualifies as a deduction. This is the sole responsibility of the very same Congress that passes spending legislation. You don’t need to have a PhD in economics to realize that if you pass a law to spend more than you are bringing in, you create a deficit, and if you bring in more than you spend, you have a surplus. And over the decades, if you run more deficits than surpluses, you build up debt. Simple math.
Spoiler alert: only 5 times in the last 50 years (the latest in 2001) did the U.S. have a surplus. It should also be noted that there is nothing wrong with running a deficit, per se. Most of us have debt in the form of a mortgage, student debt, car lease, and the list goes on. Debt can be a very useful tool to pay for things that bring immense value before you could possibly afford to save up cash to purchase them outright. Using debt to get through hard times (say a layoff or extended illness) can help stave off personal financial catastrophe.
The same thinking can be applied to our national debt. We ran up huge debts during WWII and as a result, generations of Americans and Europeans have enjoyed a level of freedom from those investments which we would all likely agree was money well-spent. The debt the U.S. incurred to pull us out of the Great Recession of 2008-2009 prevented widespread economic ruin for many of us, and also seems prudent in hindsight. We think history will look back on the spending in the recent infrastructure bill that was passed as wise investments. But all of these added to our national debt. And while our national debt is on the high side as a percentage of GDP for large industrial nations at around 123%, it is nowhere near as high as Japan’s, which is over 225%. The U.S. is in a unique position with the world’s largest economy and the world’s default currency to run large debts without any real risk of economic disaster.
But what about the debt ceiling? Back in 1917, the same Congress that passes spending bills and sets tax rates also passed a law that limits the amount of debt the government can hold at any one time. That seems insane, doesn’t it? Congress decides how much to spend and how much we take in, but they don’t let the U.S. Treasury pay the bills that they themselves created? OK, so maybe it is Congress that can, at times, act insane. Until recently, Congress acted quite reasonably in terms of raising the debt ceiling. Since 1960, they raised the debt ceiling 74 times, most of which were without much fanfare and drama. However, recently Congress has not been acting as rationally.
And this is what brings us to where we are today. A very real fear that our Congress just might be insane enough to not increase the debt ceiling. While nobody knows for sure exactly what the impact would be of the U.S. having to default, even if for only a few days, everyone agrees it would likely create chaos and could throw the global economy into a terrible recession or worse.
So, what are we doing? Or, what should we be doing, given we have no choice but to watch the potential train wreck of a U.S. default slowly approach over the next several months?
First, it is important to rationally look at the range of outcomes and to make our long-term plans based on the most likely outcome. At this time, while the risk of default is higher than it has ever been, it is still unlikely that Congress would let the U.S. default. For our long-term investments, the prudent thing to do is stay the course and do our best to avoid the inevitable stream of predictions of doom and gloom that are coming our way through all forms of media – mainstream and otherwise.
That said, there are some very real things that everyone should do just in case there is some sort of economic chaos that is triggered by the debt ceiling debacle:
Ensure you have adequate cash reserves. If you normally need to take withdrawals from your portfolio to pay estimated taxes, it may make sense to make those withdrawals now and invest those funds in a savings account. (You can earn over 3%.)
Review your home equity line of credit limits and determine if they are still appropriate.
Review your intermediate-term goals (2-3 years). If you are planning on needing large amounts of money for a home remodel or other goals, it may make sense to discuss those goals with your advisor and determine if you need to make any changes.
If you are living off the distributions from your portfolio, it may be prudent to top off your cash management account to cover a full two years of expected cash needs.
Most importantly, take comfort in the fact that we are keeping a close eye on the ever evolving political and economic landscape to ensure that your long-term investment portfolio is positioned to weather any chaotic storms that may arise. While the storm clouds of the debt ceiling can be seen, we are also prepared to ride out unforeseen storms, like the pandemic, that come out of nowhere.
If you have any questions or concerns, please do not hesitate to reach out.