Log inThe US Debt Ceiling – what is it and why does it matter? from Charlie Hancock
Over the coming weeks you may see frequent references in the news to the US Debt Ceiling. In this article I will explain what it is and why it’s important, even to us on the other side of the Atlantic Ocean.
For over 100 years, the US has operated with a limit on the total amount of accumulated national debt, which at times has resulted in the Treasury’s finances coming under pressure. The US national debt hit the limit again earlier this year, and after a lower than expected tax take in recent months, a divided Congress will have to agree to raise the limit soon. Failure to agree on an increase could result in the shutdown of major government departments as the Treasury runs low on cash.
The notion of a debt limit might seem odd, given that the national debt of the United States has increased under every president since the 1930s (illustrated by the chart below). Although debt measured in dollars seems set to increase perpetually, calls for the limit to be scrapped altogether have often been met with fierce opposition from members of Congress. As a result, the official process involving a vote to increase the limit takes place every few years. The opposition party often uses the event as somewhat of a ‘political football’, criticising the incumbent president’s administration for their levels of spending.
Occasionally, as was the case in 2011 and 2013, a stalemate between members of Congress results in a crisis, as the Treasury is forced to take extraordinary measures to reduce expenditure. The sudden cuts in government spending often have a negative impact on the US economy and weigh on growth. In 2011, amidst a downgrade in the credit rating for the US, stock markets suffered a sharp decline. Between July and October, the S&P 500 index fell by 19%. Safe haven assets rallied, with US Treasuries and Gold performing well.
At present, it’s unclear when the Treasury will reach the point at which further borrowing is required in order to fund its obligations, however, it is widely expected to be in June or July. Whilst it is almost inevitable that the debt limit will be increased in the coming months, the potential for a drawn out process which results in increased market volatility is a factor that we are monitoring closely.
Our strategies are positioned in a defensive manner at present and client portfolios would therefore be insulated from much of the volatility which could occur as a result of any debt crisis. Whilst it is unlikely that the US government will be forced into drastic measures such as department shutdowns, it is not a zero probability event. We will therefore remain vigilant to the risks which could lie ahead in the coming months.
