When the government approaches or reaches its debt limit, it creates a situation where there is a risk of default on the country's obligations, which can have serious economic consequences.
This is the typical card that the radical right plays in budget talks and we have seen it twice in the last decade.
In the event that both parties can't come to an agreement, we would most likely see:
Sharp increase in unemployment
Double digit drop in GDP
US Dollar dropping by Brexit-sized levels.
That being said, it’s still only a single digit probability and therefore we aren't making any one-sided trades that could go against us when it’s more likely approved (gold, volatility or inverse funds).
We may make some tweaks to decrease our USD exposure and invest more in non-US assets to play into longer term trends but also help minimize the losses of this black swan event, should it materialize.
The last time the radicals pulled this, Warren Buffett's Berkshire Hathaway's debt became better rated than US government debt. These shenanigans have increased the price to borrow across the board and therefore we are all worse off for this behaviour.
That being said, the government has more tools in their back pocket to avoid an outright default and it would be in their best interest to do so.
While the debt ceiling brinkmanship often generates concern and uncertainty among investors, there are several reasons why we shouldn't be concerned.
1. Historical Precedence: The US has experienced debt ceiling debates and temporary impasses in the past, but it has always managed to avoid defaulting on its debt obligations. The government has implemented various measures, such as employing accounting techniques or utilizing available funds, to ensure that debt payments are made on time.
2. Political Incentives: Both major political parties understand the potentially catastrophic consequences of a default. Despite differences and disagreements, lawmakers have consistently demonstrated a willingness to reach a compromise and raise the debt ceiling to avert a crisis. The debt ceiling brinkmanship is often a part of political negotiations and posturing, rather than a genuine intent to default.
3. Economic Impact: A default on US debt would have severe repercussions, not only for the United States but also for the global economy. It would likely lead to increased borrowing costs, destabilize financial markets, and erode investor confidence. Recognizing this, policymakers have a strong incentive to avoid such an outcome, providing reassurance to investors.
4. Central Bank Interventions: In the event of a debt ceiling crisis, central banks, including the Federal Reserve, can play a crucial role in stabilizing financial markets. They have the ability to inject liquidity, provide emergency funding, and implement measures to mitigate the impact of any potential default.
5. Long-Term Creditworthiness: The United States has a long-standing reputation for honoring its debt obligations. Despite periodic political brinkmanship, the country has consistently maintained its status as a safe haven for investors. The strength of the US economy and its commitment to fiscal stability make it unlikely that a temporary debt ceiling crisis would significantly undermine its creditworthiness in the long term.
While it is important to monitor the progress of debt ceiling negotiations, investors should take into account the historical track record, the economic incentives, and the actions that policymakers and central banks can take to manage any potential crisis and the fallout.
If you have any questions, don't hesitate to contact us.
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