The debate over the US debt ceiling between the Democratic and Republican parties has reached a tipping point as the “X-date” (the date when the US government can’t pay off its expenses) approaches. This week’s MoneySmart Financial News Digest will go deep into this subject to figure out what it means for you.
Another noteworthy event of the week is the release of the public report from Warren Buffett’s Berkshire Hathaway. The report indicated that Berkshire Hathaway had completed a $954 million share acquisition of Capital One in Q4 2022, and we’ll have a look at that.
The US debt ceiling has yet to be solved
Since January 19, 2023, when the debt limit was first reached this year, the US Congress has been debating an increase to the US debt ceiling. As the “X-date”, the date when the Treasury runs out of funds to pay for expenses, approaches June 15, 2023, the argument about raising the debt ceiling has heated up in recent weeks.
What is the US debt ceiling?
Before we dive in, let’s take a quick look at the debt ceiling.
The US debt ceiling is a legal restriction on the maximum amount of money that the US government can borrow. It was created in 1917 to keep the government from overspending. However, since its inception, the debt ceiling has been raised 78 times.
At the moment, the ceiling is set at US$31.4 trillion, which is approximately 120% of the country’s annual GDP.
Why hasn’t the US debt ceiling been raised this time?
The US government wants to raise the debt ceiling in order to meet its repayments and obligations. However, the Republican-controlled House of Representatives refuses to lift the ceiling without Democratic agreements to the “Limit Save and Grow Act” — only lifting the debt limit in exchange for sweeping government spending cuts over the next decade.
House Speaker Kevin McCarthy wants Biden to negotiate spending cuts, while the White House insists on a raise in the debt limit with no conditions attached.
This political deadlock has pushed the United States dangerously close to running out of money to pay its debts on schedule.
What are the arguments from both parties?
Biden’s proposed budget for fiscal year 2024 is US$6.8 trillion and aims to reduce inequality through increased funding for pre-schooling, childcare, and healthcare. The budget is said to be funded by tax increases on wealthy Americans and corporations. If fully enacted, the fiscal 2024 budget request would also reduce deficits by US$2.9 trillion.
Nevertheless, Republicans argue that full enactment of their bill would result in a total 10-year deficit reduction of US$4.8 trillion.
Generally speaking, Democrats believe that increasing the debt ceiling is non-negotiable and an obligation of Congress, but Republicans insist on spending caps, which the White House has ruled out.
What will happen if the US debt ceiling is not raised?
This scenario has a slight chance of occurring. However, if it does happen, the following situation is possible:
Global financial markets could be shaken if investors begin to question the value of US bonds, which are widely regarded as some of the safest investments and serve as building blocks for the world’s financial system.
First, if the US government ran out of cash to pay for public services, soldiers’ salaries, or social security benefits for the elderly, the country would almost certainly stop operating, and millions of Americans would lose their jobs, as economists forecast.
Second, another consequence of US debt defaults will be the inability to pay its creditors, including social security recipients, veterans, and government contractors. This could erode public trust in the government’s ability to fulfill its financial obligations, leading to higher interest rates and more expensive borrowing for companies. As a result, businesses may cut back on investments, while consumers may reduce spending, potentially causing an economic downturn.
Third, the possible damage to the US’s reputation as a safe haven for investment is a major concern for the financial sector. If the US defaults on its debt, it will make it harder for the country to borrow money in the future, leading to increased financing costs for the government’s operations and potentially higher taxes or spending cuts.
To sum up, a default on the national debt would have dire consequences for the US economy, leading to a recession, elevated interest rates, and eroding public confidence in the government. And even worse, the resulting economic downturn would have a ripple effect across the globe.
What should you do when the US debt defaults?
“Hope for the best, but plan for the worst.” Here are a few recommendations from economist George Brown:
- Having portfolios that are both easily convertible to cash and diversified is crucial to keeping liquid capital that can be quickly reinvested during times of market volatility.
- Gold and AAA-rated sovereign issuance, such as German Bunds, are the liquid assets to consider.
- Alongside this, safe-haven currencies such as the Japanese yen and the Swiss franc are expected to perform well against the US dollar.
- Equities are likely to face pressure, especially from companies that depend on spending or subsidies from the US government.
- In contrast, value stocks, as well as food and healthcare sectors, which are defensive and non-cyclical, may perform better.
Berkshire Hathaway’s move is unveiled: $954 million invested in Capital One
On Monday, the public company filing from Berkshire Hathaway (BRK-A) (BRK-B) was released. It showed the investment conglomerate sold $1.4 billion of his remaining holdings to custody banks Bank of New York Mellon (BK) and Minneapolis regional lender US Bancorp (USB) and invested $954 million in Capital One Financial Corp. (COF).
The move resulted in a more than 3% rise in the Capital One Financial Corp. stock’s value on Monday, May 16, 2023, after the news broke. The stock closed at $91.02 per share, up from its previous closing price of $88.17 per share.
Why invest in Capital One?
Buffett, known for his long-standing interest in the financial sector, has invested in Capital One, a publicly traded company with a market capitalization of over US$400 billion that operates across the United States, Canada, and the United Kingdom. The company boasts a strong track record and has been investing heavily in technology, which could help it potentially grow its business in the coming years.
Market commentators have speculated that Buffett’s investment in Capital One may be a sign that he believes the company is undervalued or that he is looking to diversify Berkshire Hathaway’s holdings in the financial sector. Regardless of the reason for the investment, it is a significant vote of confidence in Capital One, and it is likely to continue to be a popular investment choice for Buffett and other investors.
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