By Dr. Christopher Kuehl and Mr. Keith Prather of Armada Corporate Intelligence

Published July 26, 2023

The debt ceiling concern has recently been resolved, temporarily tabling the issue for 2023. However, it is expected to resurface in subsequent years as Congress continues to pass budgets that exceed annual revenue generation. The challenge of balancing spending and taxation is universal, and governments worldwide face the task of deciding how much revenue to raise and how much to spend. In the United States, this challenge is addressed through the budget process, which often leads to discussions on raising additional revenue through taxes, fees, tariffs, or borrowing. Bonds are commonly issued by governments, including the US Treasury, to borrow funds and generate additional revenue. Municipal bonds are frequently issued by states and cities to finance projects that cannot be covered by immediate revenue sources. While Congress routinely passes budgets that exceed revenue expectations, triggering the sale of more bonds, the debt ceiling has emerged as a contentious issue in recent times.

History of the Debt Ceiling

The concept of a debt ceiling was introduced in 1939, but it was not regularly approached until the 1960s and 1970s. Since 1960, the debt ceiling has been raised 78 times. Unfortunately, the debt ceiling debate has often become an opportunity for political maneuvering and extracting concessions. Refusing to raise the debt limit poses significant financial challenges, as it throws all governmental promises and obligations into question. Previous showdowns during debt ceiling debates have highlighted the potential consequences, such as delayed social security payments, unpaid military personnel, unpaid bond holders, and uncompensated government contractors.

America’s Debt is not Unique

Despite the need to raise the debt ceiling, little progress is made regarding the key issue of debt itself. The United States currently has a debt-to-GDP ratio of 118%. However, other countries also face significant debt challenges. For example, Japan has a debt-to-GDP ratio of 226%, Greece stands at 178%, and Italy at 135%. China's ratio likely reached 280%, but it is important to note that the majority of their debt is government-owned. The options to address this debt challenge are limited: spending considerably less or raising more revenue. Unfortunately, both options tend to be politically unpopular.

Once the debt ceiling is raised, the Treasury promptly takes action to ensure that obligations are fulfilled. The Treasury is required to make any affected funds whole and pay interest on any lapse in funding. In the aftermath of raising the ceiling, the Treasury often conducts cash management auctions to meet immediate cash demands. These auctions, although irregular, are not uncommon. However, the recent debt ceiling fight unnerved investors, leading to some loss of trust and confidence in bonds. Consequently, the cost of bond issuance has increased, triggering adverse effects on the stock market. Investors seeking safer investments, such as Treasury bonds, divert liquidity from the stock market. It is estimated that the Treasury will issue approximately $1 trillion in bonds in the coming months to cover obligations.

The agreement reached by Congress in June, known as the Fiscal Responsibility Act of 2023, includes several key provisions. First, the agreement postpones the need to address the debt ceiling until 2025, thereby avoiding potential complications during an election year. Additionally, the act imposes a cap on non-defense discretionary spending, while defense spending sees a 3.0% increase. Funding for the IRS is reduced from $80 billion to $20 billion, and funds allocated during the pandemic response will be "clawed back" ($50 to $70 billion). The act also introduces additional work requirements for assistance recipients and restarts student loan payments, which had been suspended since 2020. Furthermore, efforts to expedite energy projects and other infrastructure plans are outlined.

Although the provisions of the Fiscal Responsibility Act (FRA) of 2023 aim to address certain aspects of the debt challenge, they will have a mild impact on the overall debt. The United States currently carries a $32 trillion debt, and the adjustments prescribed by the deal are insufficient to make a significant dent. Debt will surge to $46.7 trillion by 2033 without the FRA and to $45.2 trillion because of it. Notably, programs like Medicare, Medicaid, Social Security, and Defense account for nearly 70% of the federal budget, with an additional 9.1% allocated to debt service on issued bonds.

What does all this mean for the small business owner and the average person?

There are basically three broad categories of impact:

  1. If your business engages with the government in some way – as a contractor or through some other program, there was a real risk of not getting paid. That is no longer a concern (at least until 2025). The same holds for people who are receiving benefits or payments of some kind – everything from Social Security to wages.
  2. The second category affected is more indirect. Government agencies could have shut down and they would not offer the services they were assigned. This ranged across the board and could have affected almost everybody as it would have impacted air traffic control, national parks, border protection, passports and so on. It would have been a quick lesson in just how much government impacts daily life.
  3. The third category is in the realm of investment and finance. The status of the US treasury was in jeopardy and could have experienced a downgrade from its triple A status. That reverberates through the bond market and even forces institutions to sell as many are not allowed to invest in anything less than AAA bonds.

Conclusion

The debt ceiling debate is a recurring challenge for governments worldwide. While the recent resolution postpones the issue until 2025, the underlying problem of national debt remains unresolved. Governments must navigate the delicate balance of revenue generation and spending. Addressing the debt challenge requires politically challenging decisions. The consequences of failing to raise the debt ceiling are severe, as demonstrated by previous "debt crises." Moving forward, it is essential to explore sustainable, long-term solutions to reduce debt and ensure economic stability.

About the Authors

Dr. Christopher Kuehl and Keith Prather are founders and managing directors of Armada Corporate Intelligence. Dr. Kuehl holds a Ph.D in Political Economics and Master’s Degrees in Soviet Studies and East Asian Studies. He works with a wide variety of corporate clients around the world and is the economist for several national and international organizations. Mr. Keith Prather has been providing corporations with market intelligence and analysis covering domestic and global economics, geopolitics, raw material and supply chain developments, environmental impacts and other factors that affect the corporate operating environment for more than 22 years.

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