Failure to raise the debt ceiling could trigger a further decline in the stock market. If so, history shows it’s worth buying on the bargain as politicians finally agree to raise the debt ceiling and curb some spending.
But have you ever wondered why governments aren’t spending more responsibly? After all, we as individuals have a duty to budget and spend within our means. Why shouldn’t the government do the same?
If we, as individuals, continue to spend far more than we can comfortably afford, our credit will suffer, our assets will be confiscated, and we will be excluded from society. No one will trust us if we can’t pay our debts.
Let’s explore this double standard of financial responsibility.
Why governments aren’t spending more responsibly
The concept of “spending within means” is different for governments than for individuals and households. Governments can issue debt or borrow money to finance spending. Individual households rarely do.
Here are some reasons why governments don’t always spend strictly within their means.
1) Desire to revitalize the economy
During recessions, governments may use deficit spending to stimulate economic activity and mitigate the negative effects of the recession. Increased government spending can create jobs, support businesses, and provide a social safety net. This approach aims to boost economic growth and ultimately increase government revenue.
For example, in the midst of the pandemic, governments spent trillions of dollars on devastating support and stimulus for the economy. Programs like PPP loans and student loan forgiveness have helped keep small businesses and college graduates afloat.
2) Building and maintaining social programs and safety nets
The government provides social programs such as health care, welfare and unemployment benefits to support its citizens. These programs aim to promote social welfare and reduce inequalities. Meeting these promises will often require government spending that may exceed current revenues.
During the 2008 global financial crisis, the federal government famously provided 99 weeks of extended unemployment benefits. As a result, the term “recreational employer” was coined to describe people who received unemployment benefits while traveling and playing for almost two years.
If the federal government provides extended unemployment benefits beyond the standard 26 weeks offered by state governments, the amount of retirement benefits will rise significantly. After all, if you can plan your layoffs, you can get all the unemployment benefits you want.
If you quit your job, you are usually not eligible for unemployment benefits. why? The government and your employer assume you don’t need the money just because you quit. Employers can accept or contest unemployment insurance claims.
3) Public investment for greater returns
Governments often invest in infrastructure, education, health care, and other areas to promote long-term economic development and social well-being. Often these types of projects require borrowing to cover the initial costs. It is not uncommon for multi-million scale projects to be carried out in metropolitan areas.
Such spending is portrayed as an investment in the region’s future and may be seen as justified even if it leads to temporary deficits. The problem is that we have huge deficits that will leave future generations burdened with debt and high interest payments.
If you don’t have children, you may be more amenable to government spending beyond your means. Continuing to raise the debt ceiling is a logical move to cover inflation and economic growth.
But unless you’re generationally wealthy, you’ll probably feel more stress and anxiety for your kids who have to shoulder more debt. In general, most people want to leave a better place for future generations rather than making the world worse.
4) Earnings volatility
Government revenues are subject to economic fluctuations, which can affect their ability to balance their budgets without borrowing.
During economic downturns, government spending on social safety nets may increase while tax revenues may decline. This can also create budget deficits that need to be covered by borrowing.
For example, many office buildings are less occupied than they were before the pandemic. As a result, business districts are experiencing a decline in economic activity, falling into a vicious cycle of declining housing sales, fewer restaurants, and fewer conferences.
The desire for less volatile revenues is one of the reasons local governments are struggling to lower property taxes, even as property prices are falling.
5) Political Priorities and Tradeoffs
In election years, politicians sometimes pander to the public to get more votes. Therefore, financial discipline is sometimes ignored. The more money you can freely pledge to people, the more support you will get.
If politicians cannot meet the needs and demands of voters, they will not stay in office for long. Public policy goals also influence the allocation of resources. Therefore, different priorities and trade-offs can lead to deficits and debt accumulation.
Ideally, taxpayer coverage would increase beyond about 50 percent of current working Americans. The more participation, the more tax revenue, and the more support from the people.
How much could the stock market crash if the debt ceiling weren’t raised?
Based on historical history, the largest decline in the S&P 500 during the 2011 debt ceiling debate was -19.4%. In 2013, the S&P 500 fell -5.8%.
So, if the current debt ceiling problem is not resolved quickly, the stock market could fall as well or even worse.
Equity market valuations in 2023 are in the top 15% of historical averages as economic activity slows due to aggressive rate hikes. As I wrote in my post How to Invest $1 Million Today, I don’t like buying the S&P 500 around the 4,200 level.
Sure, there could be a nice bailout rally once the debt ceiling debate is over. But basically speaking, the stock market is not a jump buy right now.
Ironically, I would rather lend the government money in the form of government bonds, which have higher yields due to debt ceiling issues. Additionally, I prefer to buy properties as a stock market catch-up.
Fitch Ratings placed the default rating of US AAA long-term foreign currency issuers on negative watch on May 24, 2023. Ratings agencies said ongoing debt ceiling negotiations have increased the risk that the government will default on some debt payments. . However, Fitch said it still expects a resolution by the X date.
Variables That Affect Stock Market Size Correction
A failure to raise the debt ceiling and its impact on the stock market will depend on several variables. Here are three main points to consider:
1) Government Shutdown
Failure to raise the debt ceiling could shut down government agencies and disrupt many sectors of the economy. A prolonged shutdown could negatively impact businesses, consumer spending and investor sentiment, impacting stock market performance.
For many in the private sector and those who favor small government, a prolonged government shutdown may be welcomed.
When the government forced small businesses to close in 2020, members of Congress and other federal employees continued to receive full salaries and benefits. This double standard infuriated many managers and employees and forced them out of business.
A longer term in power may force politicians to spend their future money more carefully. It could also help politicians become more empathetic to ordinary people who don’t have access to pensions, insider trading, or perfect incomes.
2) Policy response
The response of governments, central banks and other policymakers to a deadlocked debt ceiling could influence market reactions. If appropriate steps are taken to address the situation and restore confidence, the negative impact on the stock market could be mitigated.
A strong response to COVID-19 contributed to the rapid economic and stock market recovery in 2020. If the Federal Reserve decides to pump liquidity into the system again when the markets are crashing, as it was when the local banks failed, the stock market probably won’t sell that much.
3) Contagious potential
A failure to raise the debt ceiling could have far-reaching implications for financial markets beyond the stock market. It could affect bond markets, interest rates, credit ratings and overall financial stability.
In addition, the debt ceiling issue could trigger debt insecurity in other countries. In the event of a global confidence crisis, risky assets of all kinds could sell off significantly.
The Importance of Sustainable Fiscal Policy
Maintaining sustainable fiscal policy is essential for long-term economic stability. Excessive deficits and growing debt can pose risks to the economy, leading to concerns about inflation, a weaker dollar, US creditworthiness and reputational damage, and limited fiscal flexibility.
Foreign investors in U.S. Treasuries will demand higher interest rates because of the increased risk of nonpayment or late payments. As a result, economic activity may slow down further, creating a negative economic loop.
Achieving a balance between spending priorities, revenue generation and debt management is a challenge that requires careful consideration of economic conditions and long-term sustainability. Given America’s democratic system, resolving the debt problem can be extremely difficult.
Personally, I would prefer a higher debt ceiling with future spending cuts to increase fiscal discipline. As an investor in risk assets, I don’t want the stock market or any other asset class to crash.
I depend on the functioning of governments and credit markets to sustain and grow the economy. Ultimately, we should want to raise the debt ceiling.
But for those on the sidelines with lots of cash, or those just beginning their financial journey, the lack of a debt ceiling solution may be exactly what they want. We may be able to buy assets cheaply until politicians stop trying to threaten our lives.
financial responsibility at home
We should all continue to demonstrate fiscal responsibility despite the government’s “do as I say, not do as I say” attitude. Don’t expect the government to save you financially, given that it can hardly manage its own finances properly.
If you want to achieve financial freedom, don’t stop saving and investing. Keep spending less than you earn. Otherwise, you may find yourself in debt that you will never get out of.
Reader Questions and Suggestions
What are your thoughts on the debt ceiling debate? How is the amount to be raised determined and why? Does it matter? Will future generations really pay the price if governments continue to spend more than they can afford?
Empower is the best free tool to help you manage your finances unlike your government. With Empower, you can track your investments, review your asset allocation, and scan your portfolio for excessive fees and budgets. Staying on top of your investments is essential, even in uncertain times.
If you have a large amount of consumer credit card debt, you may be able to consolidate your debt with a personal loan at a lower interest rate. Check out Credible for personal loan offers.
For more nuanced personal financial content, join over 60,000 other users and sign up for our free Financial Samurai newsletter and email submissions. Financial Samurai is one of the largest independent personal finance sites launched in 2009.