Debt Ceiling Crisis | What If The U.S. Defaults?

what happens if the politicians in Washington can't reach an agreement on the debt ceiling and the U.S government defaults on its obligations and what should we do if anything to prepare for that possibility those are the questions we're going to tackle in today's video everybody my name is Rob Berger this is the Financial Freedom show where we talk about investing retirement and Financial Freedom if those topics are important to you I encourage you to subscribe to the channel I also send out a newsletter every Sunday morning you can sign up for that with the link below this video so this is probably not the feel-good video of the year at least not from me but it's something that I think is important and I've received a lot of questions from folks via email on this very topic as you probably know the United States actually technically reached its debt ceiling back in January that's when the treasury Department started to do what's called Extraordinary Measures they take those those Extraordinary Measures to sort of basically rob Peter to pay Paul to keep the government running it does allow them to meet all of the government's obligations and including the repayment of bonds and interest on the U.S government debt but the day is coming when unless the debt ceiling is raised they won't be able to do that even using Extraordinary Measures that date is called the X date why is it called the X date well because no one really knows the exact date they've only got estimates in part because the US government does continue to receive tax revenues we don't Finance 100 of our obligations we do actually pay for some of some of our obligations with tax revenue but some have put the X date in June others have said perhaps July or the third quarter of this year so what I want to do in this video we're going to talk just a bit about the history of the debt ceiling and then we're going to dive into three big questions and that is what is the effect of the debt ceiling crisis even if it's resolved before the X date and we've already seen some effects of this crisis already as I'll show you then we're going to look at what at least in theory could happen if the worst case does turn out and we go by the X date and the government defaults on some of its obligations for some period of time what are the what's the likely Fallout of that and then finally just a few comments on what if anything should we do now to maybe prepare for that possibility so let's Dive Right In so the the debt ceiling actually dates all the way back to 1917 when it was first enacted and it effectively in theory gives Congress control over how much the government can borrow that's sort of the the rationale that the government can't just go borrowing money unchecked so you know checks and balances in our form of government gives Congress some control over it of course as you no doubt know the debt ceiling has gone up and up and up as the borrowing and the the total debt of our country has gone up in fact here's a chart that shows you recent history and say recent from the 1980s and as you can see boy this back here in 1980 where we're looking at like a trillion dollar debt ceiling boy then that seemed like a walk in the park as you as you can no doubt see here from 2010 to our current situation it's more uh I guess it's tripled and of course the the the pandemic played a big role in that you can see the big jump right here in 20 in 2020 in 2021 so we're currently standing at 31.4 trillion dollars so that's sort of the the current state of of of play and um we of course have to raise the debt ceiling in the next couple of months or even the Extraordinary Measures won't allow the government to meet its obligations and that raises a big question all right have there been any effects already from this uh debt ceiling crisis and what are the perhaps uh upcoming effects if the crisis isn't resolved soon and we maybe we don't go past the X date whenever that is but maybe we get close to it like we did in 2011 what would be the consequences there and so let's Dive Right In we've already got some consequences that were seen in the t-bill the treasury bill Market let me show you that this is um from treasury these are the yields on treasury bills and and and and notes and bonds from one month treasury bills here to the long Bond 30 years here let's actually start with a 30-year long bond this is the yield at the beginning of this month in April 3.64 today or as of the 24th uh it's 3.73 so not not a significant change uh what that's nine basis points but now let's go to the one month it started at 470 and look at this it's now down to 354. it was actually down to 336 last week but now it's 334. let's compare that say to the three month it started at 490 not only did it not go down like the one month did it actually went up to 520. so it raises a question wait a minute why is the one month T Bill behaving differently Look it's even behaving differently than the two month which started at 479 and is now up to 509 and that gets us back to that X date that we don't know about one of the things that folks believe is that with a one-month treasury you'll get your money back before the X date or in April so you're going to get your your return on on a one month t-bill in May and so you don't have to worry about the X date whether it's in June or July you don't have to to worry about it and so a lot of investors have been piling into one month treasury bills that's increased the price of one of the one month treasury bill and that of course has caused the yield to go down now with two months or three months or longer that gets us into that X date range and that's got some folks a little nervous and so they haven't been piling into those uh duration T bills and so that hasn't caused the price to spike in fact if it's gone down a little bit as we saw and yields have actually gone up and I raises the question who are all these buyers and sellers are they investors like you and me well perhaps in part but actually it could be in the money market funds space because you have money market funds invest at least some of them do and treasury bills and they have to be concerned about liquidity and so they may be concerned about investing in t bills that could mature around that X date and so they've been focused on one month treasury bills at least to some extent and perhaps avoiding let's say two or three month treasury bills at least in relative terms and that's why we're seeing the yields fluctuate and go down on the one month T bill but at the same time go up on Two And three month treasury bills I think as we get closer and more clarity on exactly when the X date might be we're likely to see this kind of movement in the short-term treasury bill markets of course we'll keep an eye on it I'm not one to generally predict the future but we're already seeing that in the t-bill market now so that's that's one consequence we're already seeing a second one will be particularly as the crisis moves on and gets closer and closer to the X date increased government borrowing costs as people get nervous about whether the government will actually make payments on interest payments on on on their borrowings and repay principal when it comes due the cost of borrowing goes up a GAO report from the 2011 debt selling crisis concluded that U.S government borrowing costs increased by 1.3 billion it's with a B billion dollars because of that debt ceiling crisis and remember it did get resolved before the X date although it came down to the wire in 2013 there was also a debt ceiling crisis but not nearly to the same extent as 2011 it also increased a borrow government borrowing according to the GAO by but by a lot less they estimated 38 to 70 million dollars but I think the big takeaway is it can and will increase government borrowing costs particularly if the crisis continues closer and closer to that X date now that in turn like it or not is going to increase the cost for consumers for you and me to borrow every money for everything from a house uh to cars again I don't think we can know the exact uh effects on borrowing costs but I think it's it's a reasonable conclusion that is as Government borrowing costs go up as interest rates generally rise it's going to affect consumers as well what else could happen well stock market declines in this again remember we're still talking about the government not going past that X date they resolve it before then but we can still see start stock market declines because it makes the market nervous and we saw that in 2011 the stock market went down significantly it actually continued to go down even after the debt ceiling crisis was resolved why remember our credit rating the US government's credit rating was reduced by s p again it didn't default in any obligations but they went right down to the wire that caused the rating agency to lower the rating on U.S government debt and that roiled markets as well there is an irony there for you stock and bond market historians you may recall that after that happened uh folks actually did what they actually poured more money into bonds why because uh they basically was a flight to safety you have folks still viewed U.S treasuries as a very very safe place to put money and so there was a lot of action in the in the treasury bond markets in August of 2011 when this crisis was unfolding and then resolving I think the big takeaway here is that a lot of bad things can happen even if this debt ceiling gets resolved before the X date and the longer it takes to resolve it the more significant those consequences could be now that gets us into the second thing well what happens if we actually default and I think it's a fair to say I don't think it's an over statement to say that if the government actually defaults in its obligations particularly if if they do so over any you know period of time as it gets longer and longer the results would be catastrophic and I'm not one to use that word lightly but I think it's a a fair I guess I'll call it expectation should the government default now let's talk specifics first of all there would be plans in place for the government to repay principal on on treasuries on bonds that are maturing during this we'll call it the fault period And even to pay interest you might say well how how would they actually do that well the theory is this they could pay principal on maturing bonds by actually borrowing more money because they wouldn't be increasing the government's overall debt they'd be borrowing or we'll call it a hundred billion dollars here but then repaying the principal on a hundred billion dollars in maturing debt so that the overall uh debt of the US government doesn't go up now there's a big assumption there and that is that folks will actually be willing uh to roll over their debt or to invest in more treasury bonds while the government is in this default period but that's a big question we haven't actually tested that but in theory that's what they would do they would borrow money and then take that money and repay the principle of maturing debt now what about interest payments well the theory here is is they would prioritize payments of interest on the debt over other obligations remember it won't be that the government doesn't have any money at all they are getting tax revenues every month of course it varies from month to month as as we know in April when we file our tax returns they get a lot more tax revenue than they do in other months but they are still getting tax revenue every month they don't borrow 100 of their obligations thank goodness and so one theory is that they could prioritize interest payments on debt above other obligations and in fact if we go back to 2011 that was part of the plan as treasury in the FED we're trying to figure out what they were going to do if the debt ceiling crisis wasn't resolved now what about other obligations though and what about things like Social Security uh Medicare how about paying our military and government employees or government contractors how would the US government handle that well one approach would be again prioritize this was actually an approach that was uh suggested by Republicans earlier this year and the idea being they might prioritize say social security security and Medicare payments as an example and payments to the military studies though have have shown that that's not necessarily possible that it's the government's uh computer systems aren't designed to do that they make tens of millions of payments a month and it's it's not at all clear that they have the technical capability to prioritize paying this bill but not that bill and of course then there are legal issues uh that no doubt could arise from that approach but that's at least in theory one possible approach another approach would be just reduce payments is how much money we have so we'll just reduce all payments by 20 or 30 percent or forty percent whatever percent is necessary based on how much cash they have they happen to have on hand in a given month again lots of problems there the biggest one is just again technical they just don't have the computer systems that actually allow them uh to do that so it doesn't seem like a very practical solution another possibility they could just sell assets they've got a lot of gold they've got mortgage-backed Securities they could just start selling assets all of these possibilities by the way I'm not just making up they've actually been considered in fact I'll show you a report uh this was back in 2012 again as a result of the 2011 crisis this was from the office of the Inspector General the department of the treasury to the Senate finance committee where they actually walked through these theoretical uh I'll call them uh responses if the government should get past the X date and default on obligations but for each of the ones I've mentioned so far for the reasons I've discussed they've said not very practical not very good idea and selling assets They concluded the same thing not very likely it would it would undermine uh the world's confidence in the U.S and its Financial strength it just wouldn't happen and so it raises the question okay then what would they do and it's basically delay payments until they have enough money to pay all of their obligations from on a day-to-day basis so it couldn't mean getting your social security check but getting it late now one reality with this is that if the default continued for a long enough period of time the delays would actually get worse if we think about it the impact on the economy and we'll actually talk about that in just a minute but it would get worse and worse and worse and so the result would be the US government would get less dollars coming in in the form of tax payments and so uh it may be that they have to delay payments and make payments as as they have the funds on a day-to-day basis but that delay could get longer and longer and longer over time so I know I told you this wasn't going to be the feel-good video of the year I'm just laying it out there for you by the way all the things I've shown you and I'm going to show you a couple other things I will leave uh in uh in in links below this uh video so what about the economy what bad things are going to happen well there's been a lot of projections from 2011 and even more recently about what would happen if the government defaulted I'll just show you a couple very quickly again I'll link to all of these but these were this was the possible macroeconomic macro economic effects of a temporary federal debt default um here's one from an economist the cost of a crisis driven fiscal policy again I'll link to all of this uh below uh the video but what's the upshot of all of this well the first is GDP would decline again the amounts different economists have different um uh conclusions on that and of course part of that would depend on how long the the defaults lasted but GDP is going to go down Market turmoil stock market's going to go down significantly the estimates I've seen about a third but again those are just estimates I don't put a lot of stock into them but I think it's fair to say that folks uh you know the the stock market would be in turmoil with lots of volatility and a real big issue would be millions of lost jobs again the exact numbers I've seen numbers as high as 6 million I've seen two and three million but unemployment would definitely uh go up and if you think about it delayed payments on Social Security Medicare government employees government contractors obviously would affect those individuals specifically but then it would affect uh there would be carry-on effects as government contractors of course can't play the pay their employees can't pay their vendors and and so it would Ripple through the economy and so that's why I call this catastrophic I don't think anyone I don't think I've yet to see an economist say no no no this wouldn't be bad the reality is it would be bad now I suppose the good news may be for what it's worth I find it really hard to believe we're going to get to that point I know it's crazy and you're saying rob you live just outside Washington you should know better than anyone else how how dysfunctional Washington can be no I get it I really do it just I I just can't believe we would actually go over that cliff maybe I'm just being hopeful but it raises sort of the third point for today's video what in the world if anything should we do about it well I can share what I'm going to do do about it and for the most part it's do nothing not completely the first thing is I'm not changing anything about my investments I even own treasury bills some will mature before we think the X date might occur but some uh mature say later in the Summer where the X date could occur I'm not selling them I'm not changing my stock Bond allocation I'm not running out of stocks I'm leaving my investments uh where they are even if the worst case happened eventually and it may be ugly it's going to get resolved I always like to think about 2011. how does the debt crisis from 2011 affect your Investments today I think the answer is not at all same thing with 2013 it just doesn't it affects it in the moment but I'm a long-term investor how will this affect my investments five years from now probably won't at all so I'm not doing anything with my investments per se but there are two things I I am just going to make sure of and that is one I have plenty of liquidity I want to make sure I have money in the bank to cover my expenses for an extended period of time but that's normally what I do anyway it's called an emergency fund now some of my emergency fund is in t bills like I said I'm not going to sell that uh it'll mature when it matures but I am making sure that I have a fair amount of money in bank accounts which normally I do anyway at least to cover three months I just think that's a good General a place to be even in the best of times and so but I want to make sure that money is liquid for me it's a bank account importantly I'm not going to have that money in a money market fund and particularly not a money market fund that invests in treasuries again well I think the the actual defaulting obligations the risk of that is minimal if that does happen it could really put money market funds in a bad place particularly those that invest in treasuries so I want to have my money in an FDIC insured bank account to cover a few months and I normally have that anyway but I'm making you know double sure and checking the balances and calculating our monthly budget again I don't think it's going to happen but I'd rather prepare for the worst and hope for the best the final thing I am doing is I am going to be looking for investing opportunities we already saw the changes in t Bill yields frankly if that got worse and people were fleeing three month T bills and the yields were going up I'd probably buy some because eventually the government's going to pay me back at least that would be my investing hypothesis but I also might look to stocks as well if the stock stock market really does Fall by a third and I have the cash and I hope I will I would be looking for investing opportunities if that happened so there you go that's my take on the debt ceiling what's already happened even as we the the debt ceiling crisis you know continues on what in theory could happen if the US government in fact defaults and what I'm doing to kind of prepare and what I might do if investing opportunities come my way again I'll link to everything I showed you in the notes in the links below this video including by the way this article here from the committee for a responsible federal budget that I found incredibly helpful and it's got links to a ton of resources well there you go if you have any questions leave them in the comments below I'd be happy to help you out any way I can and until next time remember the best thing money can buy is Financial Freedom

Channel: Rob Berger

Views: 79,477

Keywords: debt ceiling, u.s. default, government bonds

Id: nLiVpcK_4c8

Length: 22min 0sec (1320 seconds)

Published: Tue Apr 25 2023