Not raising the debt ceiling could cause another sell-off in the stock market. If so, history has shown it is worth buying the dip as politicians eventually agree to raise the debt ceiling limit and curb some spending.
However, have you ever wondered why the government doesn’t spend more responsibly? After all, we individuals are tasked to budget and spend within our means. Why shouldn’t the government as well?
If we individuals continue to spend far beyond what we earn and can comfortably afford, we’ll ruin our credit, get our assets confiscated, and be shunned from society. Nobody will trust us if we consistently can’t pay back our debt.
Let’s explore this double standard regarding fiscal responsibility! It’s too bad there is so much infighting in Congress that we have to keep expecting government shutdowns.
Why The Government Doesn’t Spend More Responsibly
The concept of “spending within your means” for a government is different from that of an individual or a household. Governments have the ability to issue debt and borrow money to finance their spending. Individual households largely do not.
Here are a few reasons why governments may not always spend strictly within their means:
1) Desire To Stimulate The Economy
During economic downturns, governments may engage in deficit spending to stimulate economic activity and mitigate the negative impacts of recessions. By increasing government spending, they can create jobs, support businesses, and provide social safety nets. This approach aims to boost economic growth and eventually increase government revenues.
For example, during the heart of the pandemic, the government spent trillions of dollars to support and stimulate the economy from devastation. Programs such as PPP loans and student loan forbearance helped keep small businesses and college graduates afloat.
2) Creation And Maintenance Of Social Programs and Safety Nets
Governments provide social programs, such as healthcare, welfare, and unemployment benefits, to support their citizens. These programs are aimed at promoting social welfare and reducing inequality. Fulfilling these commitments often requires government spending that may exceed current revenue.
During the 2008 global financial crisis, the federal government famously provided 99 weeks of extended unemployment benefits. As a result, the term “funemployed” was formed to label those who collected unemployment benefits while traveling and having fun for almost two years.
When the federal government offers extended unemployment benefits beyond the standard 26 weeks offered by the state government, the value of a severance package goes way up. After all, if you are able to engineer your layoff, you can collect all the unemployment benefits you want.
If you quit your job, you are usually ineligible for collecting unemployment benefits. Why? Because you quit, which the government and your employer presumes means you don’t need the money. An employer can accept or contest the unemployment insurance claim.
3) Public Investments For The Greater Good
Governments often invest in infrastructure, education, healthcare, and other areas to promote long-term economic development and societal well-being. A lot of the time these types of projects require borrowing to cover the upfront costs. In large urban areas, it’s not uncommon to see projects that run in the multi-millions.
Such spending is portrayed as an investment in a locale’s future and is may be considered justifiable even if it leads to temporary deficits. The problem lies with running up a large deficit, which leads to future generations getting saddled with debt and higher interest payments.
If you don’t have children, you may be more amenable to the government spending beyond its means. Constantly raising the debt ceiling is a logical act to cover inflation and a growing economy.
However, unless you have generational wealth, perhaps you will feel more stress and anxiety for your children who will have to shoulder more debt. In general, most people want to leave the world a better place for future generations, not worse.
4) Revenue Volatility
Government revenues are subject to economic fluctuations, which can affect their ability to balance budgets without borrowing.
During economic downturns, tax revenues may decline while government expenditures for social safety nets increase. This can also result in budget deficits that need to be covered through borrowing.
For example, many office buildings are at lower occupancy levels than before the pandemic. As a result, there is less economic activity in business districts, resulting in a negative loop of fewer home sales, fewer restaurants, fewer conferences, and more.
The desire for lower revenue volatility is one of the reasons why local governments make you fight to get your property taxes lowered, even though property prices are coming down.
5) Political Priorities and Trade-Offs
During election years, politicians will often pander to the public to gain the most amount of votes. Therefore, fiscal discipline sometimes gets thrown out the window. The more free money you can promise people, the more support you will likely gain.
If politicians don’t meet the needs and demands of their constituents, they won’t be politicians for much longer. Public policy objectives also influence the allocation of resources. Different priorities and trade-offs can thus lead to deficits and debt accumulation.
Ideally, the breadth of tax payers will increase beyond the current ~50 percent of working Americans. The higher the participation, the greater the tax revenue and buy-in from our citizens.
How Much Could The Stock Market Crash If The Debt Ceiling Isn’t Raised?
Based on history, the maximum S&P 500 decline during the 2011 debt ceiling debate was -19.4%. In 2013, the S&P 500 declined by -5.8%.
Hence, we can assume that if the current debt ceiling issue doesn’t get resolved quickly, the stock market could also decline by a similar magnitude or more.
2023 stock market valuations are in the top 15% of historical averages while aggressive rate hikes are slowing down economic activity. As I wrote in my post, How I’d Invest $1 Million Today, I’m not a fan of buying the S&P 500 at the ~4,200 level.
Sure, there could be a nice relief rally when the debt ceiling debate is resolved. But fundamentally speaking, the stock market isn’t a table-pounding buy at the moment.
Ironically, I’d much rather lend the government money in the form of Treasuries, yielding higher yields due to the debt ceiling issue. In addition, I prefer buying real estate as a catchup play to the stock market.
Source: Financial Samurai
