Politicians are creating more drama than Hollywood over the federal debt ceiling.
Let's recap what we know with some educated speculation about what could happen next.
[Scroll down to the bottom for the nitty-gritty if you want to skip the details.]
What is the debt ceiling and why is it in the headlines (again)?
The federal debt ceiling is a limit on how much the U.S. Treasury can borrow to pay government commitments already approved by Congress.1
Once the ceiling is reached, Congress must either increase or suspend it so the Treasury can issue new debt and raise the money needed to cover its bills.
Once an ordinary part of federal accounting, adjusting the debt ceiling is now a political negotiation, threatening the Treasury Department’s ability to pay its bills next month.
Though it’s unlikely either party will allow the U.S. to default on its obligations, this political brinkmanship adds anxiety each time it comes up.
What would happen if Washington doesn’t reach a resolution?
Treasury Secretary Janet Yellen has warned that the U.S. could run out of money by June 1 if Congress doesn't act.1
While so-called "extraordinary measures" are being used to extend the timeline, if neither side budges, the U.S. could officially default on its sovereign debt for the first time in history.
Even if Congress quickly reversed course, a temporary default could still trigger a market correction and agitate credit markets.
Given how fragile the collective American psyche is about the economy right now, a default could trigger a recession or major job losses as businesses pull back on spending.
The chart below projects unemployment across multiple potential default scenarios that are being discussed.2
You can see that most of them could result in a spike in unemployment as a default ripples through the economy.
Bottom line: A debt default could be very bad news for global markets and the U.S. economy.
Here's the potential good news: It doesn't seem likely that either political party will allow the U.S. to default on its debts.
The price of an impasse is too high; however, it could happen, so let's be prepared for that eventuality.
What can we do about the debt ceiling showdown?
As investors, we're along for the ride.
We are closely monitoring the situation. If any changes to your strategies are warranted, we will update you accordingly.
Until then, deep breath.
We'll get through this.
P.S. Want a quick mental break from headlines? Here's a short film about giant redwoods to remind us of how beautiful and resilient our world is.
The market indexes discussed are unmanaged and generally considered representative of their respective markets. Individuals cannot directly invest in unmanaged indexes. No investment strategy can guarantee a profit or protect against loss.