The Return of the Debt Ceiling: Part 108

As the federal government prepares to go to the mattresses, should long-term investors be worried if Congress doesn’t raise the debt ceiling?

Another debt-limit debate could be heading our way.Photo by: Win McNamee/Getty Images

It’s baaaaaaaaaaack! What is? The debt ceiling! On Monday, US Treasury Secretary Jack Lew warned Congress (through a strongly worded letter, natch) they’ll hit the debt ceiling in mid-October—sooner than many expected—and we could defaultif lawmakers don’t buckle down and raise it. And, predictably, people are jittery—Congress is gridlocked! What if they can’t compromise?!To which we say, slow down. Short-term market volatility may spike as politicians hem and haw, but the probable long-term impact is close to nil—even if Congress doesn’t raise the ceiling until after we hit it, the likelihood of default is slim to none.

In his letter, Lew explained the “extraordinary measures” taken when the debt limit was reset on May 17 will soon dry up. That’ll leave the Treasury with only its daily cash on hand (about $50 billion each day) to pay the bills—probably not enough on days when the government has stacks of social security checks, military salaries and Medicare reimbursements to sign. Lew suggested this might make investors wary of rolling over maturing Treasurys, causing an immediate cash crunch and “irreparable harm to the American economy.”

Which seems rather overstated. Even if Congress dithers and the Treasury has to start operating on whatever it finds in the sofa cushions, the risk of default is exceedingly low. For one, operating on a daily cash balance doesn’t undermine the Treasury’s full faith and credit—investors know any borrowing freeze is temporary, arbitrary and doesn’t change the fundamental characteristics making US Treasurys so attractive. So maturing debt likely gets rolled over. Plus, the only true, urgent obligation is Federal interest payments. Current debt interest payments make up just 9% of tax revenue. That’s about $220 billion annually—pretty manageable with a $50 billion daily budget. Plus, with tax receipts rising, debt interest payments are drawing from an even larger pool of cash. The government might have to dial back spending, prioritize payments and suspend certain pension contributions in order to keep making interest payments, but this isn’t default. Default is missing bond payments—an exceedingly unlikely scenario.

That said, chances are the Treasury doesn’t stay in this pickle for long, if it even gets there. It’s a virtual certainty Congress will up the debt ceiling—as it has 107 times before—whether in the 11th hour or a little after. Yes, Congress is gridlocked. Yes, both sides have drawn lines in the sand: The Obama administration will not negotiate over the debt limit, while some in Congress promise a “whale of a fight” if their demands aren’t met. But this political posturing, maddening as it may be, is part of the negotiation process. Since the debt ceiling was born, legislators have used it as leverage to get what they want from the opposing party. But they always raise it, and Congress has every incentive to do it again. Congress is full of hundreds of politicians who want to be re-elected—they know their chances are slim if they do anything voters might perceive as putting the US in a precarious fiscal position. Expect plenty of political chest puffing and finger pointing, but ultimately, some sort of resolution to the debt ceiling despite the gridlock.

After all, that’s pretty much Congress’s M.O. these days. Remember the fiscal cliff? Congress reached a “compromise” on New Year’s Day after months of grandstanding. Heck, this past May Congress raised the debt ceiling with a temporary waiver! Congress’ favorite pastime seems to be kicking the can down the road—and it’s no different with this iteration of the debt ceiling. Sometimes, like in the recent student loan legislation, they break out the Congressional time machine and retroactively kick the can.

Now sure, we may see some day-to-day market volatility as politicians politick. But that shouldn’t alter stocks’ longer-term trajectory. Just like the debt ceiling, we expect this bull market to continue to rise.

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*The content contained in this article represents only the opinions and viewpoints of the Fisher Investments editorial staff.