It is a breathtakingly-pitiful sight to see the ongoing mismanagement of our nation’s finances. Last month, as you may recall, after weeks of debate, Congressional officials reached a budget agreement for the remainder of the current fiscal year. The agreement was reached just hours before the Federal Government would have begun shutting down non-essential operations. It was painful to watch adults argue for weeks about spending cuts that ultimately amounted to no more than 1% of the entire federal budget. As an American, I actually felt embarrassed by the entirely dysfunctional process.
Now we have 2-3 more months to watch another embarrassing exchange of rhetoric and inaction on Capitol Hill, this time involving a vote to increase the U.S. Treasury’s statutory borrowing authority, i.e. the debt limit. On May 16th, the U.S. Treasury officially reached its legal limitation on the amount of public debt that it may have outstanding and will likely exhaust all other temporary financing means by August 2, 2011. Given that this subject will be in the news headlines for weeks to come, I figured it was worthwhile to make a few comments on the matter.
The debt limit has actually been in place for about 100 hundred years now and has been raised dozens of times – and even lowered a few times – but it has absolutely never served a functional purpose. How could it? Imagine if you had a limit on your credit card, but also had the discretion to change that limit at any time. Would this limit your spending? Could a similar limit have any impact on our nation’s deficits and debt? Of course not. Our own government even acknowledges as much. In a letter from the Treasury Secretary to Congress on May 2nd Secretary Geithner said, “I want to emphasize that, contrary to common misperception, the debt limit has never served as a constraint on future spending…”
The past two decades have been particularly remarkable, but not in a good way. Since 1990, the debt limit has been raised 17 times, from about $2.9 trillion to the current limit of $14.3 trillion. As you can see from the chart above, the debt limit (blue line) has risen dramatically in the past few years, due to massive deficit spending in the wake of the credit crisis and recession. The Treasury Secretary is correct in saying that the debt limit has never served as a constraint on future spending. It’s quite obvious from looking at the chart that Congress has simply passed new legislation every time it was necessary to raise the debt limit in order to accommodate its ongoing budget deficits.
During 235 years as an independent nation the United States has racked-up $14.3 trillion in debt obligations, with $5 trillion of this amount (more than 1/3rd) being added in the past 3 years alone! On a personal note, I have a 5-year old daughter so it’s easy for me to think back to what I was doing precisely 5 years ago, as a frame of reference. During the past 5 years our federal debt has increased by $6 trillion, which means that our Federal Government has borrowed and spent about $19,000 for every single person in this country over the past 5 years. I have a family of 4, so my family’s share of the national debt is now $76,000 higher than what it was on the day my daughter was born in 2006.
Congress will eventually vote to raise the debt limit this summer, but you can count on it going down to the wire (i.e., very close to August 2nd) and perhaps even a few days later. The real variable in this debate revolves around what, if any, spending restrictions or austerity measures will be added to the debt limit legislation. In other words, the current vote on the debt limit itself is something of a non-issue for financial markets. Rather, what does matter to financial markets is the substance of the debate, the implementation of concrete near-term spending cuts, and the perception that our government is on a credible path toward resolution of the massive fiscal imbalances that we presently face. We are not likely to see major entitlement reform coupled with this debt limit vote, but we are likely to see other steps toward deficit reduction, such as cuts in discretionary spending, defense spending, or the elimination of farm subsidies. These are the issues that ultimately matter most to investors because these are the issues that will affect financial markets and the economy going forward.