The Debt Ceiling is Not the Issue. The Debt is.

As the shutdown continues into a second week, the public is starting to see the debt ceiling issue on the horizon.  Unfortunately the facts have become clouded in half-truths and distortions created for political reasons.  The goal is to get the public scared and thereby gain leverage.  Here are the facts:

Fact 1:  The first fact is that there is no reason for the US Government to default if the debt ceiling is not raised.  Current payments on the debt are about 1/8th of what the government brings in each year.  It is possible a debt payment could be missed if the government spends the money on other things (which may have already been done), causing a cash flow problem.  But this is kind of like a family spending all of the income from a month on a vacation before paying all the credit card bills.  There is plenty of money coming in to cover the bills.  They are just out of money until the next paycheck.

Fact 2:  The second fact is that the US national debt is important, particularly if the US continues to run large deficits.  This is because the minimum payments continue to rise as more debt is taken on.  As with a household budget, at some point – probably within the next 20 years if the US continues as it has – the debt payments will equal about half of the total revenues.  At that point the interest will compound on itself and quickly swallow all of the revenues.  The CBO currently estimates that the debt will reach these levels by 2035, and this does not include spending on Social Security and Medicare, let alone the new Affordable Healthcare Act.

Fact 3:  The high debt level leaves the US open to a crisis should rates increase dramatically.  The use is able to pay the interest payments easily because the interest rate the government pays is very low.  But unlike a home loan, where the interest rate is fixed for current loans, the government is constantly retiring old debt and issuing new debt at whatever the current interest rates are.   If they were to issue debt and get no better than 10 percent, the interest payments would triple, meaning that the interest payments would consume almost half of the national income immediately.

Fact 4:  Not raising the debt ceiling would not affect the US credit rating and interest rates, but missing a payment would.  A credit rating is an indication of how likely it is for an entity to repay their debts.  If the debt ceiling were not raised but the interest payments continued to be paid, there is no reason for the credit rating to be hurt.  In fact, the reason it was lowered the last time during the last debt ceiling debate was because a compromise that would eventually lead to a balanced budget and a reduction in the debt was not reached.  The credit rating agencies know that at some point the government will not be able to keep making the payments if the debt keeps growing, so they saw the failure to finally do something to rein in spending as an indication of greater risk.  If the debt ceiling had been held and government spending cut to essentials, the credit worthiness would improve because spending and income would be in line.

Fact 5:  Consumer rates will not necessarily rise if US government interest rates rise.  Normally consumer rates rise if government rates rise since the government is seen as the safest place to invest.  If one can invest safely with the government and get 5%, you would not buy corporate bonds unless they paid you 7%, for example.  If the government becomes more of a risk than the corporate bonds, however, bond rates might actually be lower.

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Disclaimer: This blog is not meant to give financial planning advice, it gives information on a specific investment strategy and picking stocks. 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. All investments involve risk and the reader as urged to consider risks carefully and seek the advice of experts if needed before investing.

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