The debt ceiling is the maximum amount of money that the United States can borrow by issuing bonds. It was created in 1917 during World War 1 with the Liberty Bond Act. The debt limit was initially set at $9.5 billion and is currently $31.4 trillion. Once the debt ceiling is hit the treasury can no longer borrow money to cover the deficit, and the government might face difficulties in meeting its financial obligations. This might result in a default which could have negative consequences. The Council of Economic Advisors (an agency within the Executive Office of the President) estimates a protracted default could result in a “sharp recession on the order of the Great Recession with the stock market dropping 45%.”
While that sounds intimidating (unless you’re Donald Trump who has said the consequences of a default “could maybe be nothing”), it also provides a significant incentive for congress to raise the debt ceiling. It is common for the US Government to reach its debt limit. When it does, congress usually increases it. The debt ceiling has been raised 78 times since 1960, most recently in 2021. Even if the debt ceiling is reached before it is increased, the Treasury Department can take extraordinary measures to delay a default. The US Treasury last had to take extraordinary measures in 2021 before the debt ceiling was raised to its current level.
Debt ceiling concerns can affect asset prices. In 2011, the US came within 72 hours of defaulting on its debt. During that period, the S&P 500 declined -19.4%. There were also debt ceiling concerns in 2013 that caused the US stock market to decline -5.8%. However, in both instances the US Aggregate Bond Index was positive.
There are real concerns if the US Government defaults. However, raising the debt ceiling has happened many times before and will likely happen again in the future. If history provides any insight, the US policy makers will work hard to reach a deal to increase the debt ceiling. Regardless of the outcome, it is important to own a diversified portfolio including high quality bonds. Each time the debt ceiling is reached it raises the question whether it is the best way to impose fiscal responsibility.
Bobby McBride holds the Certified Financial Planner (CFP) designation and is Financial Planner at Planning with Bobby Inc. He also holds the Chartered Financial Analyst (CFA) designation and is an Investment Advisor at Investing with Bobby of Designed Securities Ltd.