Ep. 35 Implications of the Debt Ceiling Showdown for Investors
The Financial Commute

Ep. 35 Implications of the Debt Ceiling Showdown for Investors

Ep. 35 Implications of the Debt Ceiling Showdown for Investors

The Financial Commute

On this episode of THE FINANCIAL COMMUTE, host Chris Galeski and Chief Investment Officer Meghan Pinchuk discuss the debt ceiling.

What is the debt ceiling? It is a legislative limit on the amount of national debt the United States government can incur. The government hit the debt ceiling of $31.4 trillion in January, but the Treasury Department provided the government with more cash while it figured out its next steps. Currently, Congress is trying to decide which spending cuts and requirements need to be in place before raising the debt ceiling. Unless Republicans and Democrats come to a compromise by June 1st, the government will default on its debt which could delay social security checks and payrolls, jumpstart a recession, and cause millions to lose jobs.

Even if the debt ceiling is raised, it is a short-term “fix” to a growing problem. A high level of federal debt leads to a more vulnerable economy, higher interest rates, and a more volatile stock market. So, what should people be doing to protect themselves? Meghan says investors should prepare a resilient portfolio with lower stock exposure and consider investing in gold and private lending.

As for the government’s solutions, Chris says there are only two ways for it to pay off its debt: raise taxes or let inflation rise so the real value of the government’s debt is reduced. Although it is a possibility that a temporary government shutdown could happen as Congress tries to reach an agreement, Meghan and Chris are optimistic that the debt ceiling will eventually be raised.

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Hello, everybody, and thank you for joining us for another episode of THE FINANCIAL COMMUTE. I'm your host, Chris Galeski. Joined by Meghan Pinchuk, Chief Investment Officer at Morton Wealth. Meghan, you're here to talk about the debt ceiling.

Debt ceiling, everyone's favorite topic these days.

I know. I mean, I feel like every few years we hear a little bit about it.

Yes. It's maybe been something that's more common of late in recent years.

So because we're going to talk about the debt ceiling and, you know, our listeners and our clients have a range of different knowledge around this topic. I thought I would come up with a, you know, really simple analogy on what the debt ceiling it is. So bear with me already. But essentially, the government makes $5 a year. They spend 8 to $9 every single year.

So they're constantly going into debt and eventually they reach their credit card limit and they have to go to mom and dad and say, mom, dad, I need you to raise my credit card limit so I can continue to spend. But mom and dad are divorced and they have hundreds of lawyers on each side that are fighting tooth and nail for reasons why they should or should not raise it.

And so it’s just a round and round circle. And then eventually at the last minute, the ceiling gets raised and the government can continue to spend more money.

So there were some good analogies in there. I'm not sure if that gives anyone comfort, but.

Let's talk a little bit about the facts around the debt ceiling. So in 1917, the, you know, Congress created a debt limit. Okay, we've got to have some sort of limit on what the government is allowed to spend. Then in the late thirties, 1939, 1940, this modern version of the debt ceiling was created. What it sounded like.

So people's ability to kind of, you know, when we get to our max limit of spending, you know, come to the table and said, hey, we need more money to be able to spend.

And so the debt ceiling, technically it's the legal limit that the government is allowed to accrue in terms of their outstanding debt balances. And so now we get to this point where they reach that limit and instead of, you know, austerity or cutting back, whatever it is, they say, just kidding, we just need a little bit more. And so they go and Congress has to expand the debt limit to allow them to borrow more, to have a government are more.

And so when you look back, I think it's been since 1960, it was 78 times that Congress has upped that ceiling. And when you, you might think that it was one political party versus another, but both have done it. So presidents, basically Democrats and Republicans being in power, both have been in power when the debt ceiling was increased.

But actually it's more weighted. I think it's closer to 49 or 50 that were Republican and the rest were Democrats.

That's not completely fair because Reagan did it 18 times on his own.

Reagan tipped the scales a little bit in their favor. But so it's something that's happened before. And so what's the risk of hitting the debt ceiling? The risk is, it's not that we're actually worried that the government is running out of money because they have this printing press. And ultimately the problems that could ensue from this will be such that they will be they will be increasing the debt limit.

But in the meantime, we've got mom and dad divorced, there's all this political gamesmanship going on. Each side's trying to get something out of the other so that they can move forward and increase the limit. And in the meantime, you could have it where the government can't make payroll here for people, Social Security benefits get cut.

There's real consequences to a short term default, even if creditors, for example, bondholders aren’t worried that ultimately they're going to get paid back.

Right. So, you know, our take is not that, you know, people that own our hold our debt like a U.S. Treasury bill, that they're not eventually going to get returned the money if that bond came due. Right. But it's really the disruption that this comes into play if we don't raise the debt ceiling because the government would need to stop spending.

Social Security checks aren’t going out. People aren't getting paid, so we're not paying our bills.

There's a lot of problems. And so the difference is between what you think of when you worry about credit in the bond markets. You think of an actual default if oh the company can’t pay me back. So this isn't that, it’s what you call a technical default where you're due that payment on June 1st as an example, and they can't pay yet on June 1st, it's going to take X days beyond that for them to actually make the payment.

And there's no like actual recourse. Like if a person was late paying a bill, there might be extra fees or interest or whatever. But in a technical default, that might not be the case. But in a true default, that would be the case potentially the U.S. government's debt would be downgraded and then the interest rate on the debt would need to be higher.

And that's a whole host of other issues.

And this happens in the most recent time this happened where we had the government shutdown was in 2011, and that did happen. The S&P downgraded the U.S. debt and it has not ever been back upgraded for a number of reasons. But this is again, this is tactical gamesmanship. But there are larger implications to this. Essentially, the fact that we cannot get spending under control and that this continues to be a problem over and over again.

So I think our view is that it's going to get raised. Does it get raised before we run out of money, essentially, and have some of these problems happen? That's tough. I mean, this is usually it does go down to the wire and it gets fixed. But this is we have some pretty contentious conversations happening. They say it's, what did Biden say it was?

Yeah. So Biden and McCarthy it's May 23rd for the record. This may get released. This may get released. And there could be some news that came out. But it's May 23rd. Biden and McCarthy are in conversations and they are positive and professional is I think, the headlines on CNBC.

So they're not in an outright brawl. That's great news. And I think we again, that there's not a concern that ultimately they won't get there because the problems that will, it eventually force everyone to the table. But there could be some of uncomfortableness in the meantime. And then how long do they extend it for if they eventually reach a deal to push it out?

Six months, 12 months, 18? It's not going to it's very unlikely that they would push this out to the point that it was a non-issue for years to come. And we've got an election coming. So when that happens, this will definitely be a contention point.

Yeah. And look, I think that both sides have really valid arguments in the sense that, you know, at some point in time our country or our government needs to do a better job with spending and entitlements and making sure that we just don't create exorbitant amount of debt. You know, but if you think about it, we went from, you know, call it $100 billion worth of debt to 30 something trillion.

Now that number of trillion is astronomical. And at some point, if we keep going a trillion more in debt, a trillion more in debt, like what does that mean? To me, I feel like there's only really two ways to kind of get out of that debt. And that's either raise taxes so you have enough income to pay it down or you just let inflation run away to where 30 trillion doesn't feel like nearly as much money as it does today, but.

Neither option that exciting. But it's funny you mention trillion because the idea that trillion has become commonplace. So you just a trillion, yeah it’s a trillion this, a trillion there. X years, I don’t know how many years ago. But that was not a thing, the idea of a trillion was this foreign concept. And now to your point, you're talking about 30 trillion. How quickly does that get there, if anyone wants to know what the next number is, sort of a trivia question, it’s a quadrillion. Quadrillion.

So then we're going to keep going until we learn all the new next stages in the coming year.

I hope not. But it is interesting. I mean, $10 million was a lot of money at one point in time, then 100 million, then a billion, and now the word trillion gets thrown around an awful lot.

So I think that one of the challenges that when you have this level of debt, what results is you get a more fragile system. So it is more likely, I don't know what are there going to be also how much is going to happen with markets and things like that. The answer is we don't know, of course, exactly what's going to happen, but they are more vulnerable to these types of shocks or these kinds of mini crises.

The debt ceiling is a great example of it. What's happening with regional banks is a great example. When you have this level of debt and you start raising rates into this environment, it creates it starts showing you where there are problems. And so we're seeing that. And we would expect that that to continue where some level of volatility in these kinds of areas do continue.

And likely to see other cracks show themselves throughout the world, because we are not the only country that has printed trillions of dollars over the years and had created as much debt.

And we're not alone.

Yeah, so that's some of our biggest fear. And so, you know, the doomsdayers, I think, you know, misery loves company and, you know, there's some really scary scenarios out there, but we don't see it likely that the government, you know, goes into a complete default on their debt. But there could be a technical period where there's a government shutdown and people aren't getting paid.

What should we be doing? What should our investors, what should people be doing to protect themselves or manage some of the risks we have going on here?

We think that because you can't predict this and you can't even say what's the next shoe to drop and how is this going to play out exactly? You have to just be positioned and create a resilient portfolio in advance. And so I think our investors have heard us say that a lot of late because we're kind of obsessed with it.

And so the answer is things like as we've done in recent years, lower stock exposure this year, that's not great because despite all these crises, the stock market's running. But we think that that's fragile as well. So we're just going to stick with our guidance in terms of saying we are happy with the stock exposure we have.

We're not adding to it.

And that's mainly because growth in the future is going to be more difficult for companies because it’s more expensive to borrow and grow. And, you know, margins might not continue to increase.

I think the stock market right now is pricing in that everything is going to be okay, that the Fed is going to turn around lower rates and nothing's going to break in the meantime and that earnings will stay strong. And so even if we're not talking doomsday, it just feels like the market's priced to perfection, like it’s priced as if everything's going to go great.

And so if anything goes wrong at all, I think you could see volatility there. Not that it tanks just that, you know, you can see some major moves. So you have things like that, you know, keep your stocks lower. We've been very thoughtful about our bond allocations over time, not wanting to take a lot of interest rate risk when it doesn't make sense.

It makes a little more sense now, still not enough long term that we're saying, great, let's, you know, extend out and take long term stuff. But there's interesting opportunities in bonds now, whereas we were conservative before, we can be a little more opportunistic into this difficult environment. Gold is a great one from a portfolio hedge standpoint. It's just different.

It's insurance against all of this, it’s an alternate currency, insurance against monetary debasement. Everybody printing all this money printing and the stuff that we do on the private lending side, I think it's really impactful. It's just different. It's not that there's no risk to some of this stuff. It's just it's just different kinds of risk. Can you mix in other things?

So not everything is going to be subject to the same issues that we're having, debt ceiling, things like that in the economy.

Yeah, And we just did an episode with Jeff talking about the regional banking crisis and how the changes to that environment and those regional banks might actually increase the opportunity in some things like private lending. So there's a lot that I'm sure you and our team are going to be looking at and exploring.

We are busy and there's really exciting opportunities out there. It just has to be set against the backdrop of not just looking at exactly what has happened in the past and saying, oh, no, this won't happen. You have to be a little more creative and think of all the fun things that could occur. And obviously I say fun facetiously, but it's thinking about like what are all the scenarios, like what can go wrong, how can you protect against it and still invest in a way that you can make a reasonable return in a lot of different outcomes?

Yeah, those are great points. Again, just to summarize, this is not doomsday, but there could be some real problems if, you know, the Republicans and the Democrats don't come to a solution to raise the debt ceiling before we sort of hit our spending limit. We're well positioned for it through diversification and some of the things that you talked to and, you know, this is this is a real thing. It's happened 78 times since the sixties. So it's likely not the last time that we're having a conversation about it. But thank you again for joining us here.


Information presented herein is for discussion and illustrative purposes only. The views and opinions expressed by the speakers are as of the date of the recording and are subject to change. These views are not intended as a recommendation to buy or sell any securities, and should not be relied on as financial, tax or legal advice. You should consult with your financial, legal, and tax professionals before implementing any transactions and/or strategies concerning your finances.