The U.S. Debt Ceiling

5/24/2023 - By Mark Hemby, CFA

Sometime around June 1, 2023, the United States is expected to reach its debt ceiling. In recent years this topic has caused turmoil in the financial market and impacted thousands in both the public and private sectors. So, what exactly is the debt ceiling?

The U.S. federal debt ceiling is a legal cap on the amount of debt the federal government is allowed to accumulate. It was first established in 1917 during World War I to help finance the war effort. The debt ceiling sets a maximum amount of debt that the federal government can have outstanding at any given time. If the debt ceiling is reached, the Treasury cannot issue any more debt, which means that the government cannot borrow any more money to finance its operations. In effect, this could lead the government to default on its obligations, including payments to Social Security beneficiaries, military personnel and government contractors.

The debt ceiling is determined by Congress. This limit is raised periodically to accommodate new spending and to allow the government to continue borrowing. According to the Treasury, “Since 1960, Congress has acted 78 separate times to permanently raise, temporarily extend or revise the definition of the debt limit – 49 times under Republican presidents and 29 times under Democratic presidents. Congressional leaders in both parties have recognized that this is necessary. However, the process of raising the debt ceiling has become a contentious political issue in recent years, with some lawmakers using the threat of default as leverage to push for spending cuts or other policy changes.

When the federal government spends more money than it collects in taxes, it must borrow to make up the difference. The federal government borrows money by issuing Treasury securities, which are purchased by investors such as banks, pension funds and foreign governments. The Treasury securities are essentially IOUs that promise to pay back the principal plus interest later. This borrowing adds to the national debt, which is the total amount of money the government owes to its creditors.

If a deal on the debt ceiling is not reached in time, the Treasury can take a variety of measures to keep the government running without defaulting on its obligations. One option is to use extraordinary measures, such as suspending investments in certain government funds or redeeming certain securities early. Another option is to prioritize payments, paying some obligations (such as interest on the debt) before others (such as payments to government contractors). These actions can buy the government some time to negotiate a deal to raise the debt ceiling or to reduce spending.

Currently, both parties are working on proposals to avoid a breach but it still might come down to the wire. In the short term, this uncertainty could create volatility in the financial markets until a deal is reached. For investors holding diversified portfolios of U.S. and international stocks and bonds, there’s not much more to do than ensure your allocations are in line with your targets. For investors who feel their portfolio is largely at risk due to the U.S. debt ceiling, contact Saltmarsh Financial Advisors, LLC to see how we can help.

About the Author | Mark Hemby, CFA

Mark is a senior financial advisor for Saltmarsh Financial Advisors, LLC, an affiliate of Saltmarsh, Cleaveland & Gund. He holds a Chartered Financial Analyst (CFA®) designation and as part of our investment advisory group, he works with clients to develop and implement investment strategies to achieve financial freedom while also ensuring their goals and objectives are aligned. Mark has over 15 years of experience in investment banking working with individuals and organizations to manage their portfolios and coordinate investment activities. In addition to his experience with fixed income trading and sales, Mark owned and operated his own business in Alabama.