My son recently asked me why there is so much worry about the country's debt ceiling. "After all, Dad," he said, "don't you look for companies that borrow money to grow when investing in stocks for your clients? How is this different?"
The debt ceiling issue is a complicated one, with many people involved and with many possible end results. Understanding how we got to this point and how it impacts our wallets is important.
Because this issue will continue to be in the news, let's answer some of the most common questions surrounding the debt ceiling.
What is the debt ceiling?
Created in 1917, the national debt ceiling is a level imposed by Congress on how much debt the U.S. can carry at any time. The debt ceiling is not the same as the budget process because our debt consists of spending that has already been approved previously by the Congress and the president: It is money we already spent and owe to creditors.
How did we get to this point?
This is no different than most debt situations when you do not effectively budget. Government is no different as we have seen years of prudent fiscal management and years of over indulgence. Every President since Harry Truman has added to the national debt expressed in absolute dollars. The debt ceiling has been raised more than 70 times since 1962, including 18 times under Ronald Reagan, eight times under Bill Clinton, seven times under George W. Bush and three times under Barack Obama.
Is it bad to have debt?
Deficit spending can, in general, create economic growth. Most investors look for companies who can leverage their growth through debt for greater profits down the road. When debt is effectively used, it can fuel business investment, productivity gains and consumer spending as jobs increase and our standard of living improves. The opposite occurs if mismanaged. If too much of this borrowed money is invested in areas that do not produce additional growth, the need for continued borrowing increases. Just like the business owner, politicians need to self police to prevent mismanagement of our tax dollars. There is no ideal level of debt except through the rearview mirror.
It seems like the government keeps raising the debt ceiling every few months. Why?
The debt increases each day we bring in less in tax revenue than we pay out for things approved through the democratic process. It is growing more so today than in the past for several reasons, including an increase in overall spending, funding of wars and a decrease in overall revenue from tax cuts and a lack of economic growth.
Is there a balance or sweet spot when it comes to government debt?
Historically, a country faces severe challenges if the debt to Gross Domestic Product (GDP) ratio gets too high - commonly recognized as above 90 percent (The U.S. is at 101 percent as of May 2012). At these levels of debt to GDP, a country's ability to grow and pay off the debt is difficult and, like any overleveraged company or individual, it could lead to default. Or, more likely, it could lead to a spike in interest rates as borrowers demand more return because we are unable to generate enough revenue to pay the debt back.
The worry, my son, is not over the debt ceiling, but upon the recognition that $1,000 of new debt does not mean you are $1,000 richer. Our politicians need to know how to make the discussions surrounding the debt ceiling productive because investors have serious concerns.
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