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3 months. That’s the time since the U.S. debt ceiling crisis was resolved.
But it didn’t make things any better because the U.S. has tacked on an astounding $3 trillion to its national debt.
That brings the total debt figure to a staggering $33.07 trillion!
What’s next, you ask?
The federal government is less than two weeks away from facing a potential shutdown over crossing the debt limit and a lack of funding authorization.
Let’s take a deep dive into what’s going on, how it can affect the markets, as well as some trade strategies to navigate this storm…
Understanding the $33 Trillion Problem
$33.07 trillion is a staggering figure. But how did we get here?
The simple answer is that the U.S. government spent more than it earned by borrowing more money to keep things rolling over the years.
Here’s a quick look at the government’s actual and estimated budget receipts, outlays, and deficits:
Source: whitehouse.gov
The U.S. government, operating on a fiscal year from October 1st to September 30th, largely finances its spending through debt issuance, with a limit set. The recent Treasury data indicates a significant deficit of $1.52 trillion for FY23.
To make sense of this data, economists like to assess the debt as a percentage of the gross domestic product (GDP) of a nation.
Here’s a look at how the U.S. debt has been over the last few years, up until the fiscal year 2022:
Source: fiscaldata.treasury.gov
To compare this with the GDP in percentage terms (as of FY22), the debt is around 124% of GDP. And this ratio has generally increased since 1981.
That’s a whole lot of debt and it’s higher than after World War II.
The rise has prompted the Treasury Department to begin a series of extraordinary measures to continue borrowing.
Let’s understand why this happened by taking a closer look at how the debt ceiling works.
The Debt Ceiling
The debt ceiling is not a hard cap and is often raised to allow the government to continue borrowing in order to finance its spending.
When the government reaches the debt ceiling, it can no longer borrow money and must either raise the debt ceiling or find other ways to reduce its debt. If the debt ceiling is not raised, the government may risk default on its debt obligations or shut down certain programs in order to stay within the limit.
Things start to get ugly when this limit is raised too many times and becomes a big debt pile for the nation.
Here are some latest updates on this:
The Treasury has been utilizing its remaining cash to pay the government’s bills on time. But this will end unless Congress grants it the authority to resume borrowing.
House Speaker Kevin McCarthy has proposed his plan to raise the debt ceiling. It also included the proposal to cut federal non-defense spending. He has until October 1 to get enough votes for a new spending bill. If that doesn’t happen, most federal agencies could grind to a halt.
The real cost is also the rising interest rates, all thanks to the Fed. Because as the interest rates rise, so does the cost of servicing the giant debt.
To add troubles to it, we have tax receipts that are falling. Federal tax receipts have dropped 8.4% over the past year. And that has meant a $300 billion rise in the U.S. deficit.
The Market Impact
The general consensus is that the U.S. has never defaulted on its debt and will very likely take steps to avoid a default this time around as well. And because of its reputation, U.S. debt is considered a risk-free “safety asset” in the world economy.
However, shakiness in U.S. creditworthiness could potentially result in some market turmoil, like in 2011 when the U.S. faced a debt ceiling crisis and received a downgrade in its credit rating.
High levels of debt can also make it more difficult for the government to borrow money, as lenders may be less willing to lend to a country that already has too much debt.
A higher debt can also lead to increased inflation, as the government may be forced to print more money to pay off its debts. Increased inflation could mean decreased purchasing power for consumers and lower budgets and growth outlook from businesses.
Additionally, high levels of debt can make a country’s economy more vulnerable to external shocks.
As Janet Yellen pointed out a few months back, if the new debt ceiling is not agreed upon and the U.S. defaults on its debt, it could lead to an economic and financial catastrophe.
For traders and investors, the current developments around the U.S. debt can potentially lead to more volatility in the markets.
It could also lead to higher interest rates as lenders demand higher returns to compensate for the increased risk. This could make it more expensive for businesses and consumers to borrow money and can slow the economic growth.
It’s important to note that the U.S. debt is not necessarily a bad thing as long as it is used to invest in infrastructure, education and other things that can boost long-term economic growth.
The current development on the matter is that the Congress must pass legislation to raise or suspend the debt ceiling soon or risk a government shutdown.
It could also bring potentially major market implications in the coming months.
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