[REN #348] Could the Debt Ceiling Be Lifted Indefinitely?

picture of ceiling for Real Estate News for Investors Podcast Episode #347

It’s the first time in U.S. history that the national debt has passed the $20 trillion mark. It zoomed past that milestone September 8th when President Trump signed legislation that suspended the debt ceiling for three months. By lifting that limit, the federal government is able to provide $15 billion for hurricane relief, but it also kicks the can down the road, for a debt ceiling standoff and possible government shutdown.

Republicans were stunned by the deal. Democratic leaders had proposed the idea, and the President quickly accepted it, despite objections from his own Treasury Secretary Steven Mnuchin. The Treasury Department has been resorting to so-called “extraordinary measures” to meet its obligations under the previous debt ceiling, but once it was lifted, the Treasury Department was able to start borrowing money again immediately. That quickly pushed the national debt up another $317 billion dollars, with no upper limit through December 8th.

If Congress doesn’t approve of a new spending plan and debt limit by that date, the new debt ceiling would be set at the outstanding amount, without additional funds to pay the bills. If that happens, we would again face the risk of a partial government shutdown.

Funding dries up when the Treasury Department cannot issue any more bills, notes, or bonds — otherwise known as “printing money.” And, when lawmakers increase the debt ceiling, the Treasury can issue more of those notes. They are considered “safe” for investors because they are guaranteed by the U.S. government, better known as taxpayers. They also have very low yields.

Treasury “bills” give you the lowest return on your investment because they require the shortest time commitment — under a year. “Notes” are issued for terms of 2, 3, 5, and 10 years and Treasury “bonds” have a 30-year term. Economists pay the most attention to the 10-year Treasury note. They influence the 30-year fixed-rate interest because the two are competing against each other for investor dollars. Currently, yields on Treasury “notes” are about 2.19% while the yield for the 30-year “bond” is about 2.75%.

Yields are not to be confused with the interest you get paid for buying them. They represent the total amount you get back at the end of the term, including whether you paid more or less than the face value of that security.

Slamming into the Debt Ceiling

When the government hits the debt ceiling and the Treasury can’t issue any more fixed-income securities, the government must then rely on tax revenue to pay its bills. And, if there isn’t enough tax revenue to do that, the Treasury Department gets to decide who “will” get paid. Among the choices are Social Security benefits, Medicare reimbursements, salaries for federal employees, or the interest on the national debt.

When government services are suspended because federal employees can’t get paid that’s called a government shutdown, or partial government shutdown. We experienced one of those in 2013, and it was no fun for the people who went without a paycheck.

Right after President Trump signed this latest deal, he indicated that he’s in support of “eliminating” the debt ceiling altogether. That was a huge surprise to his side of the aisle after a very vocal campaign against the growing national debt under President Obama. Republicans are apparently mystified.

The President said, “For many years people have been talking about getting rid of the debt ceiling altogether there are a lot of good reason to do that.” He said, “So certainly that is something that could be discussed.” He feels that debt ceiling battles that happen over and over again just “complicate things”. He would rather resolve the borrowing issue with a budget.

Economic Risks of High U.S. Debt

Politics aside, the amount of debt we are dealing with puts the U.S. economy at risk. According to the International Monetary Fund, the debt to gross domestic product ratio should be 77% or less for developed countries. When it goes above that, there’s concern that the country cannot generate enough revenue to cover its debt. U.S. debt is currently higher than 100% of the GDP.

There’s also talk that the nation’s triple-A credit rating could take a hit. If that happens, interest rates on its debt could increase, creating more debt. That would have a ripple effect on other parts of the economy, including the stock market.

The debt debate could also keep lawmakers from focusing on tax reform, which has been one of the things driving the economy since the President’s election. Mid-term elections will also steal some of their time, by the second quarter of next year, so their agenda could get quite busy. With the amount of time it takes to get things done in Washington, this issue could cause problems for months to come.

Right now, lawmakers have another three months to deal with the issue. Some economists say that the Treasury Department may have a few more tricks up its sleeve to postpone any D-day scenarios, if that new deadline passes without a resolution. It would give Congress more time to sort things out, but the growing U.S. debt is an economic monster that puts us all at risk, and gets more difficult to deal with as it grows larger.

How to Protect Yourself

Many people are optimistic about the U.S. economy today, as evidenced by the amount of capital pouring into the stock market.

Many companies thrive in spite of high debt. They borrow money to invest in assets that generate income. Real estate investors love debt because we can borrow 80% or more to acquire an income-producing asset, and pay off the debt through cash flow.

Unfortunately, this is not the kind of debt the U.S. is borrowing. America is more like a company that borrows just to pay bills – or to just pay the interest on the debt borrowed to pay bills.

Are the funds America is borrowing being used to acquire income producing assets? Perhaps a small sliver will go toward infrastructure growth, but the majority of funds are being used to pay entitlements and interest on debt.

Perhaps we can keep borrowing more and more and more to cover these costs. Perhaps there is no need for a ceiling to stop debt accumulation. After all, we’ve managed to get away with it for awhile now. Bush doubled the national debt from 5 to 10 trillion dollars, and Obama doubled it from 10 to 20 trillion dollars.

Common sense would tell you that can’t go on forever. But when will it hit that tipping point?

Many people are hopeful that a growing economy will cover the debt, or at least the cost of debt. A 3% GDP growth would cover interest on current debt, but with $20 Trillion dollars borrowed, we are still struggling to meet that level.

How Can You Protect Yourself?

Be cautious. Know that much of the recent economic boom is a result of debt, not output. So play defensively, as if a debt crisis were around the corner.

Don’t get over-leveraged. Don’t keep too much cash in banks. Invest in hard assets that people need no matter how the economy is doing. Be prepared for possible declines in stocks, rents and property values.

If stocks, rents and property values increase, you will be happy. If they decline, you will be able to ride out the storm.

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