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Risks of Hitting the Debt Ceiling in the USA

The United States hit the debt ceiling — also called the debt limit — in January 2023. While so-called extraordinary measures were immediately implemented in an attempt to reduce the risk of defaulting, we’re at a serious impasse months later.   

It’s clear that hitting the debt ceiling is a significant problem that raises a range of economic concerns. What does it mean for citizens and the economy, though? What are the risks?   

What Is the Debt Ceiling?  

The debt ceiling is the maximum amount Congress has authorized the US Federal government to borrow to cover its bills. While “debt ceiling” is the most commonly used term, it can also be called a debt or borrowing limit.   

When this limit is reached, the government isn’t allowed to issue further debt.   

What Major Risks Are Associated with Hitting the Debt Ceiling?  

Congress has raised the debt ceiling — allowing the US government to issue more debt — 78 times since 1960. A debt-ceiling stand-off can ensue when Congress cannot reach an agreement, and that’s what’s happening right now. These situations have always been resolved thus far, and the US government has never defaulted. 

However, the major risks associated with hitting the debt ceiling include:  

  • 1. Default — when the government can’t issue further debt, the risk that it cannot cover its expenses and obligations is the primary concern. This includes pensions, military salaries, and interest payments on existing debts. In other words, the risk is that the government goes bankrupt.  
  • 2. Market panic — it’s no surprise that this kind of instability can send the stock market into a spin. 
  • 3. Increased interest rates — Interest rates will surge unless the debt ceiling is raised. 
  • 4. Recession — hitting the debt ceiling is one of many factors that can contribute to an economic downturn or recession. A debt ceiling impasse causes consumer confidence to wane.  
  • 5. A downgraded credit rating — like individuals, governments also have credit ratings. Hitting the debt ceiling can downgrade the US credit rating, leading to unfavorable borrowing conditions and reduced foreign investments.

This is why it’s so important for Congress to reach an agreement as soon as possible when the debt limit has been reached. In the meantime, so-called extraordinary measures like selling current investments or refraining from reinvesting can hold default off for longer.  

However, the US President can also intervene under a clause in the 14th Amendment. This clause gives the President the power to take the necessary steps to prevent a default, and President Joe Biden has been rumored to be considering this already.  

What Steps Should Consumers Take?  

A debt ceiling stand-off should cause consumers to reevaluate their personal financial situations, especially if they depend on Federal income or funding (in the form of salaries, pensions, or Medicare, for example).  

Situations like this are fast-paced, so it’s important to follow the news keenly and not to panic. At the same time, a situation where the debt limit has been reached and the government risks defaulting is a prudent time to consider your financial options. They may include:  

  • 1. Evaluating your emergency fund and adding to it where possible. 
  • 2. Creating an emergency budget that severely reduces spending. 
  • 3. Diversifying your assets, including by investing in safe-haven assets such as gold and other precious metals. 
  • 4. Paying off or reducing existing debts you may have.

The fact that the US government has never, in its history, defaulted on its debt should inspire some confidence. Republicans and Democrats have thus far managed to reach last-minute agreements whenever it has been necessary, and that pattern will likely continue. If it does not, the President has special powers to prevent a default.   

Therefore, hitting the debt ceiling and inching closer to default is frightening, but it doesn’t necessarily mean that economic doom is on the horizon. As you make financial decisions, consider that fact. Take the sensible steps you wish you had already taken rather than making irrational decisions based on worst-case scenarios that are likely to be averted.   

A cool head is a key factor when it comes to rational decision-making, so consulting a financial advisor is an excellent step to take before making any major changes to your budget or investment strategy.