Shattering the Debt Ceiling Myth
Like a summer blockbuster sequel, debt ceiling chatter is back in the news, thanks partly to Treasury Secretary Steven Mnuchin’s recent Congressional testimony. In it, he warned the House Financial Services Committee the government will exhaust its borrowing authority in late summer or early fall unless Congress raises the limit. Predictably, this spurred chatter about a potential default—as if politicians haven’t kicked the can the hundred or so times this has happened before (and as if basic math and the 14th Amendment don’t stand between the ceiling and default). The debt ceiling has always been mostly symbolic: Keep it or lose it, reach it or exceed it, it doesn’t change much for the US economy.
Per the Treasury, “the debt limit is the total amount of money that the United States government is authorized to borrow to meet its existing legal obligations, including Social Security and Medicare benefits, military salaries, interest on the national debt, tax refunds and other payments.”[i] In February 2018, as part of the Bipartisan Budget Act, Congress suspended the debt ceiling until March 1, 2019. Since then, the Treasury has used so-called “extraordinary measures” to keep all checks flowing without increasing the debt level. Despite their name, we believe these measures are actually rather mundane accounting moves, such as suspending reinvestment of Treasurys in some government employees’ retirement plans. Mnuchin believes the Treasury could exhaust these measures by late summer, although many analysts believe the Treasury has wiggle room until October or November.
These days, the debt ceiling is a political football that everyone loves to hate and fight over. Yet it wasn’t always so. When Congress conceived it, their goal was to make borrowing easier and less contentious. Originally, Congress had to authorize every new debt increase. But with World War I came the need for wartime materiel purchases, requiring easier borrowing. So Congress permitted the Treasury to issue debt at its discretion up to a set amount. When debt reached the limit, Congress would vote to raise it. The first several increases were routine and not hard-fought. But in the mid-20th century, politicians discovered voters weren’t big on debt. Thus began the tradition of politicians using it as a bargaining chip and, later, tying other contentious measures to debt ceiling legislation in hopes of ramming them through when they might not otherwise pass.
While the debt ceiling is a political machination, many think it carries a real economic impact. Popular perception holds that the Treasury exhausting extraordinary measures before Congress raises the limit could cause chaos. Folks fear this would mean the US government defaulting on its debt, foreign creditors fleeing and interest rates skyrocketing—in other words, debtpocalypse. Yet this is highly unlikely in our view. For one, Congress has always raised the ceiling when needed, rendering it largely symbolic. Since 1917, Congress has acted 110 times to raise or temporarily suspend the debt limit—including plenty of times when Congress was split, as it is today. Lawmakers just have a habit of waiting till the 11th hour (or later), for maximum dramatic effect.
Even if extraordinary measures and Treasury cash on hand ran out, it still wouldn’t mean default. Default doesn’t mean delaying payments to vendors, Social Security or other supposed obligations. It is one thing and one thing only: failing to pay interest or repay principal on maturing debt. This is not a discretionary spending item. The 14th Amendment stipulates "the validity of the public debt ... shall not be questioned.” In 1935, the Supreme Court interpreted this to mean Congress’s borrowing carries with it the “highest assurance [of payment] the government can give.”[ii] In short, this means the US must honor its debt. If accounts payable exceed cash on hand in a given month, the Treasury can and must prioritize debt service above all others. Some Treasury officials have in the past shed crocodile tears saying they can’t do this, but it is a hollow claim. As the Government Accountability Office declared in 1985: “The Secretary of the Treasury has the authority to determine the order in which obligations are to be paid should the Congress fail to raise the statutory debt ceiling and revenues are inadequate to cover all required payments. There is no statute or any other basis for concluding that the Treasury must pay outstanding obligations in the order they are presented for payment.”[iii] In sum, the US pays its most important bills first, rather than pay as they come due.
That effectively neuters default risk because the US has plenty of money to service its debt, and then some. Monthly US tax revenue is more than high enough to cover monthly interest payments. In none of the past 12 months did monthly interest expense exceed monthly receipts. Monthly interest payments ranged from 8% to 31% of monthly tax receipts.[iv] This means revenues can cover bondholders, pay Social Security and Medicare benefits, and still pay other expenses. If the government had to delay some payments to vendors or workers, that would not be great for those impacted. However, it is akin to a government shutdown. The record-long 2018 - 2019 shutdown shows you those aren’t economically catastrophic. Plus, interest payments aren’t a surprise. They are on the calendar years in advance. Treasury officials can always bank revenue ahead of a high-interest month, on the outside chance they think it is necessary to avoid default.
Some folks understand the debt ceiling’s symbolism, which is why proposals to remove it or change it have arisen. For example, Senator Brian Schatz recently proposed repealing the debt ceiling, arguing: “The debt ceiling isn’t about fiscal responsibility, but about unnecessary brinkmanship” and that “no one should ever be able to use the full faith and credit of the United States as a political bargaining chip.”[v] However much sentiment drifts in favor of nixing the debt ceiling, and however much we would welcome relief from all the cat-fighting, we have a hard time seeing politicians surrendering their favorite campaign wedge issue. Not that this matters a ton either way, though. If they did delete it, reduced squabbling may help sentiment and remove one recurring source of investor worries, but it wouldn’t fundamentally change the US economy or fiscal situation. We have over 100 years of evidence to that effect.
Meanwhile, politicians are already perhaps zeroing in on a can-kick. Senate Majority Leader Mitch McConnell has proposed a two-year budget deal between the White House and congressional Democrats and would raise the debt ceiling to a to-be-determined level. But if recent history is a guide, we believe they won’t act fast—not while it is a perfectly good stump issue for this summer’s Democratic primary debates.
So get ready for what we believe will be some grandstanding and hyperbolic warnings of default—and be ready to tune it out. Even if Congress dithers over raising the debt ceiling, default isn’t always the automatic outcome.
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