Breaking the Debt Ceiling

Story Highlights:

• On Monday, the US hit the $14.3 trillion debt ceiling—and Treasury rates were flat to down.
• The US will suspend federal retirement funds investments until August 2 to allow the government to continue borrowing in debt markets.
• Despite political posturing, Congress will likely raise the debt ceiling—as it has more than 90 times before.
• The debt ceiling is a political issue much more than a fiscal issue.

Well, it happened. On Monday, the US hit the $14.3 trillion debt ceiling. And across the board, US Treasury rates were flat to down—not what you’d expect if the world were panicking about the debt ceiling breach and an ensuing US default. On the one hand, none of this is catching anyone by surprise. On the other, it’s likely markets find this to be a non-event.

One outcome could be a bit more urgency to raise the debt ceiling—politicians on both sides have been dragging their feet and/or making political hay on this topic. We also wouldn’t be surprised if this instigated further political rhetoric. Example: Treasury Secretary Geithner said he will have to suspend federal retirement funds investments until August 2 in order to allow the government to continue borrowing in debt markets—a move he calls “extraordinary.” To each his own, we suppose, but we have done this before. Not frequently—but it’s a legitimate tactic that’s been used before with no lasting ill effects.

The likeliest outcome from all this is (drum roll, please) Congress raises the debt ceiling. Congress has already raised it more than 90 times since 1940 (10 times since 2001). In our view, the debt ceiling debate is now and always will be more about political posturing than fiscal responsibility. We find no evidence of a proven, absolute level of debt that’s automatically good or bad. Plus, no one is forcing us to obey this ceiling. This is a legislative issue, and legislation makes it go away. And despite political wrangling, ongoing economic growth will make further debt ceiling raises an absolute necessity—though when and how often depends on a variety of factors. But if our economy keeps growing (as it always has, in fits and starts, throughout history, forever), even if the debt ceiling is moved to $100 trillion, we’ll hit it—one day. Frankly, we’re not sure why we have a debt ceiling at all. Make no mistake, we’re not fans of ever-increasing relative debt (mostly because we prefer government to be smaller relative to the private sector). We just think a debt ceiling serves little purpose outside of a periodic opportunity for political posturing.

Now, what if Congress decides to be (more) difficult and doesn’t raise the debt ceiling and August 2 comes and goes? It could happen. Increased political infighting could cause some near-term volatility (adding to the back-and-forth, sideways market action we think likely for 2011). But the US doesn’t automatically default. If the political fisticuffs continue, legislators will just have to make choices. Then, if forced to choose between, say, subsidies for alternative energy and paying our debts, our guess is even the silliest politician opts for covering debt obligations.

Some compare America’s debt ceiling breach with the PIIGS’ fiscal weakness—not an equal comparison, in our view, for myriad reasons we’ve written about before. Another reason? Neither Greece, Portugal nor Ireland is accepting bailout funds because they hit an arbitrarily legislated absolute debt ceiling. Rather, debt markets became increasingly expensive for them (for a variety of reasons), making servicing their debt very difficult. In comparison, US debt costs have been and continue to be extremely manageable—our 2011 public debt servicing costs will be roughly $207 billion (about 1.4% of GDP; tiny!).*

Politicians can debate till the cows come home, but if history is any indication, the debt ceiling will be raised—and raised again if necessary.

* Congressional Budget Office