All over the news, there is talk of default, jobs lost, interest rates soaring, and general pandemonium. There is certainly a lot of fear, stoked by the White House, leaders from both parties, and the news media. So what will happen to jobs, interest rates, entitlement programs, and 401k’s if the debt ceiling isn’t raised?
Let’s first take a look at the US budget:
Income: $2.6 Trillion
Interest on debt: $0.4 Trillion
Social Security: $0.8 Trillion
Medicare/Medicaid: $0.7 Trillion
Department of Defense: $0.8 Trillion
Other Spending: $1.1 Trillion
Total Spending: $3.8 Trillion
Budget Deficit: $1.2 Trillion
If the debt ceiling is not raised, the US would have $1.2 T less to spend than it is currently spending. The President, as leader of the Executive Branch, would need to decide what gets paid and what does not if income is not sufficient to meet expenses and money could not be borrowed.
Looking at the numbers, it quickly becomes apparent that there will be no default on the debt, meaning that interest not be paid, unless the President decides to default on the debt for political reasons. Otherwise, because the interest amount is only $0.4 Trillion, the Government could continue making interest payments easily using current income. Likewise, Social Security and Medicare/Medicaid could also be paid.
Almost all of the funding for the Department of Defense could be maintained as well, lacking only $0.1 Trillion or $100 billion dollars out of $800 Billion, or a little more than 10%. This means that all of the troops could be paid and most of the research and development and acquisition programs could be continued. Of course, this would mean that the other departments (State, Education, Justice, etc….) would get no funding, which is unlikely. It is therefore likely that many of the acquisition programs would be suspended to allow the main functions of the other departments to continue. Unfortunately, the Executive Branch has yet to release a contingency plan, saying instead that they expect the situation to be resolved.
Based on the numbers, the following will likely be the result if the debt ceilig is not raised:
1) The interest on the debt would continue to be paid, so there would be no default. It has been reported that while the White House has been issuing dire warnings about default, the President has been secretly telling the banks not to worry.
2) Social Security checks would continue to go out, and Medicare bills would largely be paid (although there may be some restrictions on some services).
3) The military would continue to be paid, although some contracts would be delayed and some non-vital functions might be cut.
4) There would likely be furloughs of large numbers of Federal employees and suspension of contracts. If the debt ceiling were never raised, a permanent cut in the size of government would be needed – about 40%.
5) It is very likely non-critical functions like the National Parks would be suspended indefinitely. It is also possible that they may be reopened but with large user fees.
6) Activities such as highway construction might be delayed or extremely reduced.
While this would be rough on Federal workers and contractors, the effect on the stock and bond markets would likely not be significant. There may be a bit of a sell off at first due to the uncertainty and the effects of the government no longer spending future revenues, but things would soon stabilize. Investors should therefore do the following:
1) If 401K/investment assets are not needed for 10 years of more, leave things in place. If possible, start building up cash from income to buy more shares on the way down.
2) If assets are needed within the next 10 years – for retirement, for example – start to sell off enough for needed funds. Note that this is always the advice – stocks are not a safe place to store money when needed within the next 5-10 years due to market volatility.
3) If inflation is a concern – which it may be if the government starts printing money to pay for debts – be sure to include foreign stocks and stocks in basic resources (oil, mining, basic materials, etc…) as a hedge against inflation.
4) If you are a Federal worker or contractor, or live off of research grants, it would be wise to build up a large emergency fund by delaying unneeded expenses. This may also mean selling some stocks, but preferably outside of a retirement account since the penalties of using retirement assets before retirement are significant.
It is important to look beyond the political hype. The news media and politicians are being very irresponsible with talk about default when there is no reason for a default even if the debt ceiling were not raised. Investors need to look beyond the hype and stick with their plans.
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Disclaimer: This blog is not meant to give financial planning or tax advice. It gives general information on investment strategy, picking stocks, and generally managing money to build wealth. It is not a solicitation to buy or sell stocks or any security. Financial planning advice should be sought from a certified financial planner, which the author is not. Tax advice should be sought from a CPA. All investments involve risk and the reader as urged to consider risks carefully and seek the advice of experts if needed before investing.