Perspectives from an Economist, an Investment Manager and a Retirement Planner on the Debt Ceiling Deadline
What If the Debt Ceiling Isn't Raised by the Deadline?
While I don't expect that our government would default on their debt obligation, I'm more open than ever to the possibility that anything can happen these days. Knowing that we are quickly approaching the debt ceiling deadline, I took some time to ask the opinion of our economic consultant, as well as one of the investment managers to which we have access for the benefit of our clients at our firm, California Retirement Advisors, and how it may impact your retirement. My question to the economist was specifically about the potential impact to Money Market Funds comprised of Treasuries and also to Government Bonds.
The debt ceiling deadline is coming up in a month. Here are three perspectives on this subject.
An Investment Manager's Perspective on the Debt Ceiling Deadline
There is a limit on the amount of debt the government can issue – the debt ceiling. Because the government spends an increasing amount of money over time, the ceiling needs to be raised periodically. We’ll be hearing more about this because the ceiling is projected to be hit around June 1.
We’re in limbo right now because Congress and the President don’t feel pressure to fix the problem until markets really freak out. And the markets aren’t freaking out because they believe Congress and the President aren’t dumb enough to default on the government’s debt. So, they wait until the last minute.
Ironically, what often happens in this situation is demand for U.S. treasury bonds goes up. Prices rally and interest rates decline. That’s because in times of uncertainty U.S. bonds are considered a safe haven – even when the uncertainty stems from the possibility of U.S. bonds defaulting. Markets are weird.
If the debt ceiling is raised on time, we go on with life. If something crazy happens first, stock prices might drop. I’d be happy if that happened because I could take advantage of the short-term mess to buy more stocks. I’m ready either way.
An Economist's Perspective on the Debt Ceiling Deadline
The first thing to remember is that it would be idiotic to default, so the odds are infinitesimally small. But never underestimate the power of a politician on either side to make an idiotic decision. The chance is small, but not zero.
Second, like with Social Security, even though we would not have enough to pay all of our bills, we could pay most of them. We receive money every day in tax receipts, etc. So then it becomes a matter of prioritization. I think the gov't would try to keep all the balls in the air by paying the debt immediately due and stiffing big bondholders who won't come after them (cough, the Fed, cough). The Fed owns more than $8 trillion of our debt, or about 25%. I'd imagine they could figure out how to keep things going while the financial press goes crazy, demanding an end to the impasse.
I think there is almost zero risk to money market funds and government bond ETFs. If a default happens, yields will go crazy, but just for a minute. If that occurs, grab all you can with both hands. Clients can always put their cash into deposit accounts or CEDRs, and protect millions of dollars under FDIC insurance.
A Retirement Planner's Perspective on the Debt Ceiling Deadline
I think it is important to remember that the debt ceiling deadline takes place every year, but it is often misunderstood. The primary decision to raise the debt ceiling has to do with the need to pay the "past debt" for spending that has already taken place last year. While the debate about how to better spend government resources going forward is a valid and much needed conversation, the reality is that we need to pay our past bills, just as any of us would do in our own household as responsible consumers. However, if we realized we had overspent, we would ideally come up with a plan as to how to both pay our current bills owed and how to reduce or ideally eliminate the chance that we would find ourselves in a similar debt situation in the future. The most common-sense solution for us and the government is to simply curb our spending. However, we also may have the ability to find other ways to generate more revenue, be it a side hustle by moonlighting at Home Depot or these days maybe even learning how to create video posts to generate passive revenue from advertising. The point being is that we wouldn't allow our credit to go into shambles before paying our bills, and hopefully neither will the government. The overspending conversation and proposed solutions should begin, not end, each year with the passing of the debt limit. Like tax planning, managing the budget is a year-round sport, not just one to be had during the debt ceiling deadline season. It won't be an easy conversation to have, nor will it involve politically appealing solutions. But being a leader and being responsible to do the necessary things aren't always popular. One not so small difference of course is that the government has a printing press, and we don't.
Remember, I stated that as consumers within our own household budget we can potentially figure out a way to generate more revenue as a way to solve a spending issue. Since the government can't seem to ever find a way to effectively curb spending, as a retirement investor it would be prudent to ask yourself, "how will the government generate more needed revenue?"
If your answer is, "By the government raising our taxes", you have just come to the most important realization as to why focusing on how to position your own retirement plan, especially your IRA, 401(k), 403(b) and other retirement assets in a way to generate more tax-free income in the years ahead is critically important to your wealth and to your successful retirement. If your financial advisor hasn’t started sharing ideas about how improve upon your tax diversification with more tax-free assets and income, consider the annual debt ceiling debate a financial wake up call to inevitably higher taxes and the need for tax reduction planning for a more secure retirement.
Schedule an appointment to talk to one of our financial planners today.
By Christian Cordoba
CERTIFIED FINANCIAL PLANNER™
Founder, California Retirement Advisors
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