Our elected representatives have been playing a dangerous game with our economy, our standing in the world and the financial well-being of every American. Our country’s debt stands at $14.3 trillion which is the equivalent of $129,000 for every taxpayer in America. Our debt has reached its maximum legal limit unless Congress votes to raise the debt limit. The deadline for raising the limit is August 2nd. Failing to do so could mean that the U.S. would default on its payments. Should Americans be concerned? And what is the likely outcome of this current drama?
It’s important to gain a perspective on the size of the problem. Currently, the six largest annual expense budget items total $3 trillion:
- Medicare/Medicaid: $821 billion annually and rising.
- Social Security: $715 billion annually and rising.
- Defense spending: $701 billion and rising.
- Income Security (supplemental income security, unemployment, earned income credits, nutrition assistance, etc.): $415 billion and declining.
- Net interest on our debt: $212 billion and rising.
- Federal pensions: $211 billion and rising.
The total annual federal spending amounts to $3.6 trillion while current annual revenues are only $2.2 trillion, leaving an annual shortfall of $1.4 trillion. To simplify this a bit, the U.S. government is spending about 64% more each year than it takes in. Think for a moment how this would play out if you ran your finances like this. You would quickly see that you are on a disastrous path and to solve the problem, you’d first need to ‘stop the bleeding’, meaning cut expenses (or increase revenues) so that you’re not digging a deeper and deeper hole every year. Then you’d want a plan to chip away at your debt. This is where we are today as a country.
If congress were to fail to raise the debt ceiling, how would it affect you? First, it’s highly unlikely that the members of the House and Senate will not adopt a compromise bill that allows for raising the debt ceiling before the deadline. I’d put the odds of a compromise bill at 95%. What the bill will look like is anybody’s guess. The republicans want it to focus on expense cuts with a balanced budget amendment and no tax increases. The democrats want tax increases on the wealthy but no cuts in Social Security, Medicare or Medicaid.
Second, if they don’t reach a compromise, our government would likely choose to make the payments on our debts as scheduled, in other words, no default….while foregoing other federal expense obligations.
Finally, if there was a default, I would expect interest rates to rise and the stock market to fall, perhaps sharply. On a national level, rising interest rates would exacerbate the federal debt problem. On a personal level, your costs of borrowing money would rise as well. A falling stock market would likely be temporary with a full recovery within a short number of weeks or months. Gold would likely rise sharply, if only temporarily. In a worst case scenario, bank funds could become log-jammed temporarily; suggesting holding some cash might prove wise. Overall, an anemically improving economy would likely reverse course.
All-in-all, the fallout from a default is too high a price to pay and the members of congress, for all their posturing, are well aware of this.