Questions on the debt ceiling
Q: I do not understand why some of our political leaders are unable to compromise when it comes to raising the debt limit. Why are they making such a big deal about this?
A
: This column is about financial planning, not politics, so I am going to try to answer your question in purely historical and economic terms. Please note that when I use the term “public debt,” I mean the national debt.
Public debt is deeply rooted in the American experience. Tracing the history of our public debt can bring some context to the current debate about the federal debt ceiling.
Public debt has been with us from our earliest days. The Continental Congress paid for a significant portion of the Revolutionary War by issuing $43 million worth of loan certificates to France and the Netherlands. In 1791, Alexander Hamilton federalized the states' debts and the national debt grew to over $75 million.
Over the years, the size of our national debt has ebbed and flowed depending on the politics and economics of the moment. The Civil War brought the first massive expansion of the national debt. In 1860, the year before the Civil War, the national debt totaled $65 million; five years later it stood at $2.7 billion—a 4,000 percent increase. During World War I, total public debt grew from $3.6 billion to $26 billion and then to $40 billion during the Great Depression By the end of World War II, the national debt had grown to $258 billion. After World War II, the growth rate of public debt increased dramatically, reaching to $5.7 trillion by the end of 1999. Today, our national debt totals $31.5 trillion.
Since both political parties bear responsibility for the massive expansion of the national debt, it seems reasonable to expect them to find a constructive way to deal with the debt ceiling.
Q
: What is the debt ceiling and should I worry about it?
A: The debt ceiling is the total amount of money the federal government is authorized to borrow in order to meet its existing legal obligations such as Social Security and Medicare benefits, federal employee salaries, interest on the national debt, tax refunds, and other payments. Once the ceiling is reached, new legislation is required to extend the limit further.
If Congress does not extend the debt limit, everything
we expect the federal government to do for us may be reduced or delayed. If you rely on Social Security or Medicare or work for the federal government, you may have something to worry about. If you own U.S. Treasury bonds, notes, or bills, you may see your interest and principal payments delayed.
Q
: What will happen if the debt ceiling is not raised?
A: The impact would depend on how long the impasse lasts. A short delay would result in a shutdown of the federal government. We have seen a government shutdown several times before. It is aggravating, but not the end of the world. A longer delay would be something very different.
A longer delay could result in a default on U.S. Treasury obligations and would be a serious blow to the U.S. in the global political economy. Treasury
securities are the foundation of most financial asset prices around the world because they are considered the safest and most liquid assets in the world. Treasury bonds are not just a symbol of American power and prestige, they are a practical instrument for projecting American influence to all corners of the globe.
Q
: How should I invest if I am worried about the debt ceiling?
A: Sound principles provide a strong foundation during difficult times. Your best course of action is to make sure your portfolio is properly structured to meet your withdrawal needs and that you are invested in a well-diversified portfolio of high-quality assets. The debt ceiling impasse should resolve itself quickly and not affect your long-term investments. Keep them focused on high-quality stocks or
stock funds. However, if you need to make withdrawals between now and year-end, you may want to carefully consider your exposure to U.S. Treasury obligations and ask yourself what a delay in getting your money would mean to you. If you have zero tolerance for a delay, you might consider increasing your balance in your checking account or putting some of your money in CDs at high-quality banks. You will give up yield, but the liquidity may be worth it.
Steven C. Merrell is a partner at Monterey Private Wealth Inc., an independent wealth management firm in Monterey. He welcomes questions you may have concerning investments, taxes, retirement, or estate planning. Send your questions to Steve Merrell, 2340 Garden Road Suite 202, Monterey, CA 93940 or email them to smerrell@ montereypw.com.