Breaking Down the Debt Ceiling Fight

Do you have debt? Chances are, you do. And so does the government.

As you’re probably aware, the government’s level of debt is enormous, and right now, it’s trying to fund it. There is quite a stir going on as the government decides how it is going to deal with the fast approaching “X” date.

Increasing the Debt Ceiling

One misconception many people have about the debt ceiling is that increasing it gives the government permission to spend more money. While the government does receive extra money, this is for services that have already been performed. The money needs to pay bills in full and on time.

Back in May, the debt ceiling was set at $16.699 trillion, as CNNMoney reports. That will run out this fall, which means the government won’t be able to pay its bills.

This isn’t a new strategy. The debt ceiling has been increased 79 times since 1940, so that’s more than once a year. What’s different each time the debt ceiling is increased is how it is done.

Many times, one party wants to pull money from somewhere to fund bills, and the other party refutes this, saying it doesn’t agree with that strategy. Right now, for example, many Republicans defunding Obamacare – something that won’t stand up in the Senate. 50 to 80 Republicans are opposed to funding the Affordable Care Act, and the House has voted to repeal, delay, or defund the bill 40 times, Bloomberg reports.

The government has had money since May, and it’s been paying its bills by pulling money from exchange rate funds. But money isn’t going to last forever. In fact, if a decision is not made by Oct. 1, the Treasury Department won’t have the authority to pay anyone and the government could face a shutdown.

There are some options for increasing the ceiling, but none seem to satisfy everyone enough be part of a decision:

• Increase the debt ceiling by a small amount to see how long it will last to pay the bills.

• Increase the debt ceiling by a large amount, so the issue won’t come up again for a while.

• Increase the debt ceiling temporarily, and then reduce it when the government is back on its feet.

• Prioritize the bills so that the most important ones get paid and the others don’t until there’s enough tax revenue to cover it.

The problem is, if the U.S. ends up defaulting on its bills, it will end up hurting the economy and markets in a way that scares everyone, particularly investors.

What Investors Need to Do Now

Everything going on right now compounds the debt ceiling situation. The Fed is considering a tapering of its bond buying program, and the Syria crisis is still in the resolution process. The debt ceiling increase will affect whether the Fed will taper or by how much, and the Syria crisis will affect how the Fed will proceed.

Quincy Krosby, market strategist at Prudential Financial, told Reuters:

If the debt ceiling debate heats up to the point that it is seen by the Fed as creating the kind of uncertainty that dampens consumer confidence, and you see the price of oil escalate, further eroding confidence and consumer spending power, the Fed could announce a considerably smaller scaling back than initially planned.

If the Fed tapers while there is a threat of a conflict in Syria, many investors will run from U.S. assets because it’s almost certain markets will decline.

With the debt ceiling battle in 2011, the S&P 500 declined 15% from July to September. The battle wasn’t as difficult back then because the government didn’t have a huge initiative trying to be funded at the same time, like Obamacare.

The best case scenario is that Syria forfeits its weapons, the Fed decides to only take a small chunk out of its bond buying program, and a decision on the debt ceiling happens quickly. If that were to happen, the stock market will perform much better, and investors can feel free to dive in and profit.

For right now, wait and see what to do about your investments. It won’t be long before everyone knows what will happen with Syria, and the Fed is having another meeting September 18th to decide about tapering. By that time, everyone may have a better idea of what Congress is going to do. At least that’s what everyone is hoping, since Oct. 1^st will be right around the corner.

If you liked this article, you may also enjoy:

• Debt Ceiling Investing
• Americans and Credit Card Debt