“Binge-drinking alcoholics” or astute stewards of capital?

Dr Francois Stofberg
Managing Director: Efficient Private Clients, with Specialist Input From Renier Van Zyl

Ray Dalio, a billionaire hedge fund manager, once described politicians who continuously raise the debt ceiling in the United States (US) as “a bunch of alcoholics who write laws to enforce drinking limits”. And to no one’s surprise, the US has, once again, reached the point where they need to increase the debt ceiling.

In January, the US hit its $31.4 trillion debt ceiling and, essentially, set itself up for D-Day (Default Day) a few months later. Janet Yellen, Head of the US Treasury, had to inform House Speaker, Kevin McCarthy, that Treasury was taking measures to ensure that government will be able to keep on paying its bills. Over the next three months, McCarthy will have the near-impossible task of uniting two deeply divided parties, especially in terms of who is to blame for the current debt crisis. What is certain is that, with the looming 2024 elections, neither of the parties will let the other off the hook.

But how did the US get to this point? The US’ national debt has been growing for decades, owing to wars, economic downturns, and major policy initiatives. Two significant periods of debt growth occurred between 1940 and 1950, and between 1980 and 1990, when the US borrowed heavily to finance its war efforts and to support the economy. However, the most significant increase in US debt occurred after 2000, primarily owing to the Global Financial Crisis and the COVID-19 pandemic. During this period, low interest rates and government’s belief that they could pay back the debt later encouraged increased spending, which far exceeded their income. In fact, 2001 was the last time that the US government’s revenue exceeded its spending.

It seems an easy solution to continuously raise the debt ceiling without any repercussions but there is a point where it becomes more difficult, owing to higher interest rates. For example, this year the interest payment on US debt is estimated to total $395.5 billion, which is more than government will spend on primary and secondary education. Once the debt limit is reached, Treasury cannot sell any more bonds or securities to pay off the debt from previous deficits, which will result in a default of some sort. A default would severely damage the US government’s credit rating and erode confidence in the US bond market. This, in turn, will cause investors to panic-sell, which can lead to a financial crisis. However, it is important to note that the US has never defaulted on their debt before, and we doubt it will happen soon.

There are steps that the US government can take to avoid defaulting on its debt. Democrats and Republicans can agree to raise the debt ceiling again. Additionally, government can use some of the funds in its Exchange Stabilisation Fund to pay down its debt and it can even reduce some of its wasteful spending. Furthermore, government could consider increasing revenue through tax reforms, such as increasing taxes on high-income earners. Overall, a combination of responsible spending and tax reform can help the US government to avoid a default and to maintain its financial stability.

Even though the US government’s debt levels are a symptom of a bigger problem, it will need to take significant actions to address this problem to avert a fallout in the short term that can shake the entire global financial system. What is certain is that the US will almost certainly raise the debt ceiling again in the future, which will simply result in the debt bomb being kicked further down the road.