Full Faith and Credit of the United States
March 9, 2023
Executive Summary: The US bumped up against the debt ceiling in January 2023, preventing further borrowing until Congress addresses the issue. If Congress does not raise, suspend, or eliminate the debt ceiling, the US will default on debt obligations sometime in the July to September time frame. Two great unknowns are involved: the first is what would happen if there is a default. It’s never happened before, so we don’t know for sure. In all likelihood, the negative impacts are worse than we imagine. The second unknown is what a small group in the House of Representatives, the same group that held up the election of Kevin McCarthy as Speaker of the House, will do during the debt ceiling negotiations. The national debt should be of great concern to all Americans. Full stop. That said, the time to address the national debt is not when you are on the cusp of a default. Our working base case is that Congress will debate the issue through the summer and will ultimately raise the debt ceiling and avoid a default on US Treasuries.
"Being an expert in the debt limit is a little like being an expert on termites. Nobody is really excited to hear the news you have to share, but they do need to know it."
- Shai Akabas, Director of Economic Policy, Bipartisan Policy Center
No such thing as risk-free
There is a concept that underpins our financial system that is so fundamental that we take it for granted. The idea I am describing is that the debt of the United States is “safe,” so safe as to be deemed “risk-free.” The obligations of the US are said to enjoy the “full faith and credit of the United States.” Unfortunately, this concept is currently at risk due to the 2023 edition of the Debt Ceiling Crisis.
Power of the Purse
The Constitution bestowed Congress with the "power of the purse," which shall include raising money through taxes, deciding where to spend money, and paying the debts incurred along the way. Bestowing this power on Congress, while the Treasury in the Executive branch writes the checks, is in line with the founding father's division of power.
Raising money through taxes: “All Bills for raising Revenue shall originate in the House of Representatives, but the Senate may propose or concur with amendments as on other Bills.”
— U.S. Constitution, Article I, section 7, clause 1
Spending money: “No Money shall be drawn from the Treasury, but in Consequence of Appropriations made by Law; and a regular Statement and Account of the Receipts and Expenditures of all public Money shall be published from time to time.”
— U.S. Constitution, Article I, section 9, clause 7
Borrowing money when the spending level is greater than the tax revenue: “The Congress shall have the power to borrow money on the credit of the United States.”
— U.S. Constitution, Article I, section 8, clause 2
You will notice that there is no mention in the Constitution of a debt ceiling. Instead, our approach to managing the public debt has been driven by crisis. From the writing of the Constitution until World War 1, Congress directly approved every debt issuance. In 1917 Congress passed a law that established a limit on the issue of new bonds. As we headed into World War 2, Congress passed what we now think of as the debt ceiling, which limits the aggregate of all Federal debt.
Said another way, Congress approves a budget every year, and every year Congress almost certainly knows that the budget will exceed tax revenue coming in. According to data from the OMB (the non-partisan Office of Management and Budget), in the 50 years from 1972 to 2021, there were only four years of “surplus” where the Federal Government spent less than what was brought in through tax receipts. Deficit years are funded through borrowing and are added to the existing debt until the total accumulated debt reaches the statutory debt ceiling. In essence, Congress has set up a system where they approve a budget every year, knowing there will be a shortfall or deficit. That’s a pseudo-crisis.
I am not saying that concern about the national debt is not warranted. The exact opposite is true. To use an analogy from personal finance, the time to have a rational discussion with your spouse about an expensive purchase - say, for example, that ski boat you’ve always wanted - is before you buy the ski boat, not when the bill comes due. (Note: this has no bearing on my personal situation whatsoever, so please don’t ask me about the boat that I don’t own.)
How much debt are we talking about?
The current debt ceiling is 31.4 Trillion dollars. That number is somewhat hard to fathom, so let’s get a little help from the unofficial US debt tallying website US Debt Clock (www.usdebtclock.org).
According to the US Debt Clock, the total US Debt implies a debt of over $94,000 for every US Citizen. That means my household of 4 people (two adults and two children) owes approximately $360,000 of that debt. But wait, it gets worse if you only look at “taxpayers.” When you exclude children and persons with income so low as to pay no Federal Taxes, the number bumps up to $246,000 per taxpayer. That means my household is on the hook for about $492,000.
The numbers get worse when you look at the trends for the expense and income related to Social Security and Medicare. Those obligations are, at least for this conversion, off the balance sheet. They are off the balance sheet because they are essentially promises made but don’t come onto the balance sheet until the check gets written. These entitlement programs are a complicated topic that I will unpack in a future letter.
What is the debt trend?
One way to measure the size of the debt is to compare it to the GDP (Gross Domestic Product, which is a measure of goods and services that change hands in the US every year). To draw a comparison to personal finance, the larger your paycheck is, the larger the home mortgage you can afford. You run into trouble when the ratio of your income to the size of your mortgage gets out of whack.
This measure, debt as a percent of GDP, has been trending higher since the early 2000s. The historical peak of 106% happened during World War 2 when the US had to borrow heavily to fund the war machine.
Every year the CBO (Congressional Budget Office) puts out a report with a forward-looking estimate of debt as a percent of GDP. The July 2022 version of this report, "The 2022 Long-Term Budget Outlook", contained some dire predictions.
"In CBO's projections, debt as a percentage of GDP begins to rise in 2024, surpasses its historical high in 2031 (when it reaches 107 percent), and continues to climb after that, rising to 185 percent of GDP in 2052."
We don't know what a sustainable upper limit is for debt relative to GDP. There is no absolute number at which things fall apart, and the debt becomes unsustainable. What I can say definitively is that the limit is not infinite. The graph below shows exponential growth, eventually putting us into territory never explored before.
Figure 1: The US National Debt as a Percentage of GDP over time. Source: Congressional Budget Office
Editors note: There are some interesting nuances to the figures published by the CBO. Some sources, including the Federal Reserve, add back in some obligations left out by the CBO. Other analysts add unfunded Social Security and Medicare obligations to the national debt. Either of these methods paints a much more dire situation. Because the CBO provides the best data and analysis, we have focused on those numbers and the trends they represent, not the underlying accounting methods.
What are “extraordinary measures”?
On January 19, 2023, Janet Yellen, the head of the US Treasury, informed Congress that the Treasury had reached the debt ceiling. Hitting the debt ceiling means that the US Treasury can no longer issue bonds, basically how the US government borrows money. Hitting the debt ceiling doesn't mean that the government ceases to function since there is money in every week from payroll withholdings and various other forms of revenue. To avoid the scenario where the Treasury can't pay the bills, which will eventually happen, Treasury is deploying "extraordinary measures."
What exactly are "extraordinary measures," you ask? In short, extraordinary measures are accounting tricks meant to delay the need to write a check. These tricks do not forestall the actual obligation; they delay the actual paying for the obligation. One example of an extraordinary measure is delaying the contributions required to fund the Federal Employee Retirement System (FERS). There is some leniency in the timing of contributions to the FERS system. Since the Treasury is not writing a check to fund the FERS obligation (yet), it simply doesn't count as part of the debt. Extraordinary measures are a short-term gimmick.
There will come a day, and there are too many variables at play to know exactly when that day will be, when the Treasury does not have enough money coming in to pay all of the obligations of the US government. What would likely happen on that day is that the Treasury would send out Social Security payments instead of paying to keep the government running, paying government employees' salaries, or making bond payments. That last item, failure to pay the interest on bonds, would put the US Government into default.
The day of the default has been dubbed the "X date" by the Bipartisan Policy Center think tank. The Treasury has not committed to an actual "X date", indicating only that the X date will arrive sometime between July and September.
What happens “if”?
The question is often asked, "what happens if we default on the debt"? The simple truth is that we don't know as it has never happened before in modern history. There are varying theories about what would happen and degrees of concern if a default should happen. The most obvious would be that US Treasury bonds would be downgraded from their current "safe" status, which means that they become less attractive to investors, and therefore the borrowing costs of the US would significantly increase as investors shy away.
The more significant concern relates to the opening comments: US bonds being considered "safe" is a basic assumption in all financial models. What secondary effects will there be if that assumption doesn't hold up? What other downstream impacts are there that we still need to consider? It is an unknowable unknown.
In 2011 Jerome Powell, now Chairman of the Federal Reserve, was working for the Bipartisan Policy Center. That year a similar debt ceiling crisis emerged. Powell was so concerned about the potential for a default that he developed a 51-page PowerPoint (still available online) and made the rounds on Capital Hill, news outlets, and just about anybody else would listen to him talk about the risks of default. The four most significant risks the Powerpoint identified were: [an increase in the] interest rates for US Treasuries; the status of the dollar [as the world reserve currency]; the economy; and the global financial system.
Whims of Congress
In most years, raising the debt ceiling is simply a formality. The issue comes up, Congress votes to increase (or suspend) the debt ceiling, and the story never hits your news feed. Figure 2 shows an overlay of the debt ceiling and national debt from 1994 to 2021. According to the US Treasury, Congress has acted 78 separate times since 1960 to permanently raise, temporarily extend, or revise the definition of the debt limit - 49 times under Republican presidents and 29 times under Democratic presidents.
Figure 2: The debt ceiling over time. Source: Axios
However, this year may differ from prior years if we take guidance from the process of electing Kevin McCarthy as the Speaker of the House of Representatives in January 2023. In that situation, approximately 20 Republican members of the House of Representatives held up the election of Mr. McCarthy as Speaker. Mr. McCarthy eventually prevailed by making concessions to these house members to secure their votes. The media has widely speculated that this small but vocal group will make it difficult to raise the debt ceiling before the X date. We shall see how things develop in the coming weeks and months.
According to the Oxford dictionary, pragmatic means "dealing with things sensibly and realistically in a way that is based on practical rather than theoretical considerations."
In the short term, I believe that Congress is ultimately going to prove pragmatic. The political theatre, histrionics, and performance art on display around the debt ceiling discussion will run through the summer of 2023. As the deadline nears, Congress will eventually raise or suspend the debt ceiling, avoiding a default. Being pragmatic, and doing what is needed to avoid the unknown that lies beyond a default, would be in the country's best interest in the short term.
In the long run, I hope that Congress finds a way to balance income and spending. When discussing personal finance, I have described the formula as "simple but not easy": individuals and households must live within their means. The Federal budget has lived outside this universal truth for 46 of the last 50 years. We have gotten away with it up until now, and will likely get away with it for the foreseeable future. At our current trajectory, that will not last forever. I also hope we start discussing the debt during the budget discussion, not when we hit the debt ceiling limit.
I still vividly recall having a spirited debate about the national debt in a Macro Econ course in college. The professor took a Keynesian-type position that deficit spending was good for the economy, annual deficits were the norm, and the national debt was of no concern. He asked the students to take the other side of the argument. It is worth noting that at the time of this debate, debt to GDP was about 50%. Now that the nominal debt (in non-inflation adjusted dollars) is about four times higher, and the debt to GDP percent has doubled, I have wondered if he would now take the other side of that argument as his position.
I've attempted to keep political opinion out of this piece. You may read political leaning in something I've written; know I've worked hard to avoid it. Instead, I have focused on the numbers and trends. (Side note: can you imagine how popular my new political party, the Fiscal Responsibility Party, will be when launched? I'm thinking the tagline will be: As much as we hate paying taxes, we believe in fiscal responsibility more. Higher taxes AND less spending is patriotic!)
The answer is simple but not easy: as a nation, we must do better at living within our means. Otherwise, the national debt will eventually and inevitably reach unsupportable levels. Nothing less than the financial viability of our nation is at risk.
If you just can’t get enough on this topic, here is a partial reading list that influenced this writing:
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