Given the debt ceiling drama going on, I thought it appropriate to address the situation as many subscribers have asked for my thoughts.
The following email comes from Nicolas Valdes-Fauli, one of our advisors at Main Street Financial Solutions (and former student) who sent it out to his clients last Friday.
I really like it because it discusses the debt ceiling, who owns USA debt, the political theater and how serious defaulting would be even if it is incredibly unlikely. Both sides know there is enough revenue from taxes to pay interest on the debt, Social Security, Medicare, and many other programs. After all, the government is still taking in money for the various taxes, whether it be payroll (Social Security/Medicare), corporate, or individual taxes. The issue is the government would NOT have enough money to pay for EVERYTHING so federal employees may not be paid (and therefore not go to work to do their job), passports would not be issued, national parks may close, etc., etc.
The clowns in Washington DC (on both sides) insist Armageddon will occur if spending is limited or the government shuts down. Both sides know it will be resolved at some point, hopefully this week or in the coming weeks, but they want to scare the American public as much as they can and gain political points.
Personally, I wish both parties could act like adults and do what is best for the American people and not for the people on the fringes of either party. Whether it is this week or this month, it will get resolved. There is a small chance it won’t be resolved in the next month but as of today, May 31, I think it will be handled sooner rather than later.
Here is Nicolas’ email.
The history of the United States raising the debt ceiling is a complex tale of economic challenges, political negotiations, and evolving fiscal policies and has been a recurring issue since its inception. Talk of the United States defaulting on its debt is something that takes over the news cycle every few years and allows politicians to flex, chest pound and browbeat each other into conforming into each other’s political will. It’s important to remember that although the media paints this time as “different” the game remains exactly the same and I believe it will have the same outcome: a new debt ceiling.
Before we explore what would happen if the US defaults, let’s look at this very important question:
Who owns our debt anyway?
I often hear people concerned that “China owns the United States.” This statement is wrong on many accounts, and I would like to explain why.
There are many owners of United States debt both foreign and domestic. Here is a breakdown:
You might be surprised to learn that the largest purchaser/owner of US debt is the United States government itself. Within the US, here is how ownership is spread out.
Here is the breakdown of the largest foreign holders of our debt. Japan is actually the largest holder.
So, what would happen if we defaulted?
In the event of a debt default by the United States, the repercussions would be severe, affecting both the nation and the global economy. Here are some potential outcomes:
- Global Financial Crisis: A US debt default would trigger a significant financial crisis. The value of US Treasury bonds would plummet, causing substantial losses for investors worldwide. This would create instability in financial markets worldwide.
- Higher Borrowing Costs: The cost of borrowing for the US government would skyrocket. Investors would require higher interest rates to compensate for the heightened risk, making it more expensive for the government to finance its operations and manage its debt. This could force the government to cut spending on other measures like the military, social security, and Medicare.
- Economic Recession: A debt default could push the US economy into a severe recession or even a depression. The US would most certainly lose its status as the world’s reserve currency. This would affect the purchasing power of Americans and American corporations, drive up import prices, and have implications for international trade and economic stability.
- Damage to Reputation: A debt default would damage the US government's reputation for responsibility. Trust in the US as a liable borrower would be undermined and this loss of credibility would have long-term consequences.
- Global Impact: Financial normalcy would collapse as the interconnected nature of the global economy means that a US default would have far-reaching effects worldwide.
Given these potentially catastrophic consequences, it is imperative for the United States to take measures to avoid a debt default. The long and short of it is there are many entities reliant on the debt obligations of the United States, including the United States itself! Additionally, every pension fund, mutual fund, life insurance company and bank calculate all projections based on the guarantees from government bonds.
If the US were to default, the impact would be catastrophic, therefore, I believe it will be avoided.