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Wealth & Well-Being

Debt Ceiling Brinksmanship: The Only Thing We Have to Fear is Fear Itself

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Once again, the politicians in Washington D.C. are embroiled in a heated battle over raising the debt ceiling limit, with both sides letting the world know they are dug in despite the looming threat of a "catastrophic" default on U.S. obligations. It seems like it is déjà vu all over again, except fears over a government default and a resulting economic calamity are being hyped up by politicians and the media with a "this time is different" mantra. Is it, though? 

Congress Has Never Failed to Raise the Debt Ceiling

Every couple of years, on average, going back to when the debt ceiling was created in 1917, Congress has been tasked with passing legislation to raise it when government borrowing increased federal debt to the statutory limit. More than 100 times, Congress has never failed to raise the debt limit. Without that, the Treasury cannot borrow any more money needed to pay government obligations, such as government salaries, pensions, entitlements, and interest and principal payments on existing debt. 

In the past, raising the debt ceiling was considered almost automatic as a part of doing business as government expenditures continued to increase, especially to allow for wartime spending during World War II, the Vietnam War, Afghanistan, the Iraq War, and the War on Terror. 

Will This Sharply Divided Congress be the First to Default?

More recently, as U.S. debt has spiraled out of control amid a much more politically divided landscape, politicians of both parties have used the debt ceiling threat as leverage to wring concessions out of each other. The debt ceiling battle has become a popular form of political grandstanding meant to garner support for or against each party's spending agenda and make it appear that both parties are "tough on debt." 

This time the Republicans are arguing for spending cuts to narrow annual budget deficits that have ballooned since COVID-19 relief spending, and the Democrats, notably President Biden, are insisting on a non-negotiable debt ceiling increase without conditions. Treasury Secretary Yellen has stated that the government could run out of money in early June. 

Why This Time Is Different

With the debt ceiling deadline just weeks away and with history as our guide, we can surmise that this time may be different—but not for the reasons you may think. Yes, the politics over this debt ceiling debate are more divided; and both parties are seemingly much more intractable than in the past. But just as it has done for the last 106 years, we believe that Congress will pass new debt ceiling legislation to avert a major catastrophe. It is just not in anyone's political interests not to do so. 

The brinksmanship playing out in D.C., while unnerving, is mainly for scoring political points, which is nothing new. No one, not the President nor any congressperson, wants to be responsible for the first U.S. default in history. That is no different than any time in the past. Based on current negotiations, it will be close, and as the deadline grows near, the fear factor will increase, probably causing increased volatility in the financial markets. We have seen that before. 

So, what is different this time? The markets. Unlike in 2011 and 2013, when the markets fell precipitously in the runup to the deadline, they currently appear to be taking the current drama in stride. Yield spreads are stable. The CBOE Volatility Index, the most widely followed measure of stock market volatility, is relatively calm. And the S&P 500 Index is still trading at a valuation very much in line with its historical average. 

That is not a picture of markets concerned over much of anything, much less an impending financial calamity. How can the markets remain so cool while everyone else is wringing their hands? Because the markets do not believe Congress is irrational or foolish enough to allow the U.S. to default. 

The markets have been through this before. And, while it is true they fell sharply in the month leading up to the deadline in 2011 (-17.2%) and 2013 (-4%), they roared back (28.1% and 21.4%) in the 12 months following those declines. 

Or the markets may be signaling that if a default occurred, it would not be as harmful as feared. 

Investor Fear Could Be Greater Risk than an Actual Default

While even the threat of a U.S. default is concerning, the fear of one occurring could be a more significant risk to investors than an actual default. As legendary investor Benjamin Graham famously observed, "The investor's chief problem—and even his worst enemy—is likely to be himself."

If the past is prelude when it comes to debt-ceiling dramas, any market decline is likely to be temporary. As with all market declines prior, investors who have riden through them have been rewarded with rising stock prices over time. Those who sell in fear are likely to hesitate to get back in, potentially missing out on some of the biggest gains as the market recovers. 

Even if we consider the worst (yet unlikely) case scenario—the U.S. defaults and global markets crash, sending the economy into a deep recession—that is why we invest in the companies we do in our portfolios.

In any scenario, we advise staying invested in your carefully constructed, globally diversified investment portfolio, structured for your personal financial goals and risk tolerances. Trying to time the market to “sit out” for any bumps in the road that might occur can come with costly consequences.  

If you are interested in learning more, we would be happy to offer more insights and analysis about it. We’re also here to review your portfolio mix any time your personal circumstances may warrant a change. Otherwise, we advise you remain disciplined to your investing goals and leave the political brinksmanship-as-usual to Washington. If you’re not sure, please give us a call. We always enjoy hearing from you!

Written by Alexa Darbe in collaboration with Lexicon Advisor Marketing

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