National headlines have been dominated by speculation about the debt ceiling over recent weeks, and it’s nearly all doom-and-gloom predictions. Political disagreements around the self-imposed debt limit have led us back to the precipice of another US government default. If this scenario seems familiar, that’s probably because it’s far from the first time we’ve seen this negotiation play out in the public eye.
According to the US Treasury, since 1960 Congress has acted 78 separate times to permanently raise, temporarily extend, or revise the definition of the “debt ceiling”, a limit imposed by Congress on the amount of debt that the US Federal government can have outstanding.1 During the Obama and Trump presidencies alone, lawmakers ‘kicked the can’ on debt ceiling negotiations seven different times. Each time, a deal was eventually reached, and the catastrophes forecasted in headlines didn’t materialize.
We don’t want to make light of the possible consequences of a default or a downgrade; at the same time, we recognize that this is a negotiation, and classic public negotiation tactics should be expected. While headlines can make it tough to find reasons to be optimistic, it’s helpful to look to the historical patterns of similar negotiations to put current events into context.
What History Shows Us
The US has never failed to make principal or interest payments on its debt because a deal couldn’t be reached on the debt ceiling. Most investors expect a “déjà vu” scenario, given the record of past negotiations. Either policymakers will once again squeak out a compromise in the 11th hour before the “X-date” or they’ll agree to a temporary suspension of the ceiling that pushes further negotiations out by several months.
In many ways, 2011 offers the most useful comparison for the current debt ceiling episode: both feature a Democratic President with a divided Congress, combined with an uncertain economic outlook and a recent bear market in stocks. In 2011, the issue was resolved by an 11th-hour compromise with a $2.1T increase to the debt ceiling. This increase was offset by more than $900B in deficit reduction measures with a mandate to find more savings in order to avoid automatic spending cuts known as sequestration.2 Politicians are in the self-preservation business, and there is little upside to being known as the policymakers who caused a delay in Social Security or Medicare payments.
Although a deal was ultimately reached, the credit rating agency S&P downgraded the United States’ credit rating for the first time in history based on a viewpoint that “America’s governance and policymaking [was] becoming less stable, less effective, and less predictable.” The outcome in 2011 avoided the worst-case scenarios highlighted in the press, but did reveal that even getting close to a default can create problematic ripple effects in the economy
Treating the Symptom, Not the Cause
While it is vitally important that a deal is reached to raise the debt ceiling in the short-term, the reality remains that this does not directly address the underlying issues of government spending and revenue. As a comparison, in personal finance, increasing your credit limit may solve a short-term liquidity issue, but it does not address the need to control expenses or increase income to manage debt effectively. Understanding this, lawmakers will likely pair any debt ceiling deal with an agreement to limit future government spending, and those details can be the most difficult part of the negotiation.
Debt ceiling negotiations will probably remain heated right up until the 11th hour. We expect both sides to take an extreme initial position, to emphasize the ‘sense of urgency’, and to magnify the consequences of not getting their way. They will occasionally ‘walk away from the table’ to make a point. This has played out over the past two weeks as negotiators have walked away and then returned to negotiations multiple times. Ultimately, the political pressure to get a deal done will increase exponentially as the deadline nears, and that will incentivize lawmakers on both sides to reach a compromise that can be presented to their base as a victory.
To be clear, investors don’t doubt the government’s ability to meet its obligations; it is simply the wavering political will to approve those payments and the possibility of a delay that temporarily disrupts markets. The strength of the United States credit is supported by strong economic fundamentals, excellent market access and financing flexibility, and favorable long-term prospects, along with the dollar’s status as a global reserve currency.
This, Too, Shall Pass
The lesson for investors, which can feel difficult at times, is to maintain a long-term outlook in the face of short-term volatility. In a speech on September 30, 1859, Abraham Lincoln recounted a story that still holds relevance in 2023. He said that “an Eastern monarch once charged his wise men to invent him a sentence, to be ever in view, and which should be true and appropriate in all times and situations. They presented him the words: And this, too, shall pass away. How much it expresses! How chastening in the hour of pride! How consoling in the depths of affliction!”3
Even with the guideposts of history, we still get the question: could this time be different? Or, will markets be volatile as investor fear escalates in the coming days and weeks? Both are possible, but in our opinion, neither of these concerns warrants changes to long-term portfolio goals and settled risk profiles. Markets are fast-moving, and even if there is a shutdown, it likely will be short-lived. In the 2011 and 2013 debt ceiling crises, and other similar market shocks, prices have recovered quickly once a resolution was reached. While each shutdown presents its own particular challenges and obstacles, the “déjà vu” aspects of this negotiation make it more likely that lawmakers apply lessons learned in past cycles and ultimately reach a deal.
Whether markets are jittery with fear as we’re seeing in current headlines, or giddy with excitement as we’ve seen in past rallies, experienced investors maintain a steady portfolio that is regularly rebalanced back to their long-term target. In the midst of the current moment and the spectre of the debt ceiling, we return to that time-tested perspective that “this, too, shall pass” and the patient investor will be rewarded in the long-term.
Resources
1 Congress has revised the debt ceiling 78 times since 1960. An expert explains why NPR.org
2 The lessons of the 2011 debt ceiling crisis, explained by the negotiators who were there Vox
3 This quote was also used in 1852, in a retelling of the fable entitled “Solomon’s Seal” by the English poet Edward FitzGerald.
