As the talking heads on TV debate the chances of the U.S. raising the debt ceiling past its current cap of $28.4 trillion, many, including Treasury Secretary Janet Yellen and JP Morgan Chase
For those curious as to what the debt ceiling actually is, here is a little background. The debt ceiling was put in place in 1917 to allow the government to borrow money to help pay for World War I, but it didn’t turn into a political issue until 1953, in the Senate battle over funding the construction of the U.S. interstate highway system.
Secretary Yellen is pleading with Congress to raise the debt ceiling immediately, warning that the U.S. Treasury will run out of money around October 18 if Congress doesn’t act. (The CBO, seeing a bit more runway, says late October or early November.) In an op-ed for the Wall Street Journal, Yellen writes that if the debt ceiling isn’t raised, almost 50 million seniors will stop receiving their Social Security checks, U.S. troops will go unpaid, and the U.S. will emerge as a permanently weakened nation. She warns of equally dire financial consequences: the country falling into recession and millions of jobs lost, with the likely increase in interest rates affecting almost every citizen who wants to purchase anything traditionally bought with credit (homes, cars, etc.).
Not raising the debt ceiling (especially amid a global pandemic during a fragile economic recovery) would be the financial equivalent of setting off a nuclear bomb and would destroy the U.S. reputation for creditworthiness while hurting the dollar’s standing as the world’s reserve currency. Contrary to some opinions, it would not reduce government spending: 97% of the debt due is for expenses incurred under past administrations.
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So, what is an investor to do? We think it extremely unlikely that Congress will invite economic calamity by refusing to raise the debt ceiling—the stakes are just too high not to act. Even so, the odds of default are not zero. Could the stock market correct substantially if the government defaults? Absolutely—and with the markets close to an all-time high, now may be a good time to review your stock market exposure. If a temporary drop in your portfolio of 20%-30% is too much for you to handle, then regardless of the political climate, reducing your equity exposure could free you to make rational decisions while letting you weather a market swoon. The most important thing is not to panic and sell everything if the government defaults and the markets enter freefall. In March 2020, when the coronavirus was raging and equities were plunging, selling stocks was the worst move an investor could have made. (See our Forbes article from March 2020 for our playbook on what we thought investors should do.) The apparent crisis turned into a once-in-a-generation buying opportunity, with many high-quality companies more than doubling their March 2020 panic lows. The best thing investors can do is to keep some cash on the sidelines, positioning themselves to take advantage of market turmoil.