By now the dust has settled on the recent debt ceiling crisis that plagued the government and distressed a few economic experts. The crisis, while scary and potentially fatal to the economy, is a healthy reminder about the importance of financial planning and preparing for the unexpected.
What Exactly is a Debt Ceiling?
The U.S. government relies on borrowing to fund its many expenses — paying federal employees, the military, Social Security and Medicare, and national debt and tax refunds interests. There is a maximum amount of outstanding debt the government can legally accrue which is typically set by Congress — this is what’s known as the debt ceiling.
If the government exceeds the confines of this ceiling, it can be fatal for the economy. When it reaches the debt ceiling, it’s again up to Congress to increase the limit so the government can meet its remaining financial obligations.
The Potential Effects on the Average American
It’s worth noting that the government has never defaulted on its debt. Still, if the unthinkable happened and there was a loan default, this is what potentially could happen:
A partial government shutdown may follow if it cannot borrow enough money to meet its financial obligations. The repercussions are the suspension of non-essential government services, furloughs of federal employees, layoffs, and delays in payments to contractors and beneficiaries.
Risk of Default
Exceeding the debt ceiling raises the risk of defaulting on the country's debt obligations, affecting its creditworthiness, interest rates, and overall economic stability throughout the world.
Financial Market Volatility
Increased volatility in financial markets will make investors wary, leading to higher borrowing costs, decreased investor confidence, and potential disruptions in the bond market.
Financial markets may react to concerns about the government's ability to manage its debt, leading to fluctuations in investment returns and retirement savings.
- Social Security benefits may experience delays in payment.
- Medicare spending, disruptions, or payment delays may also occur.
- Tax refunds: Treasury Department may need to prioritize spending, leading to potential delays in processing and issuing tax refunds to individuals.
- 401(k) plans: Market volatility can impact investment returns and overall performance of 401(k) investments.
- Uncertain economic conditions will also impact job security, wage growth, and everyone's financial stability.
Downgrade in Credit Rating
A low credit rating makes government lending risky, resulting in higher borrowing costs, which affects interest rates for businesses and consumers. Various interest-bearing financial products like mortgages, auto loans, credit cards, and student loans will soar upwards. Higher interest rates raise borrowing costs, making it more expensive to access credit and potentially impacting your budget and purchasing power.
Credit deficits increase the money supply in the economy, which leads to inflation. Inflation erodes your purchasing power of money by raising the cost of goods and services over time. You may experience higher living expenses and reduced buying power as a result.
The Importance of Financial Planning
Clearly, defaulting on its loan is a scary proposition for the government and the people, but it’s a great teaching point about the importance of financial planning. The byline is “plan for the unexpected” and the debt ceiling crisis is a hyperbolic version of the unexpected.
A financial professional’s main focus is to guide you through:
- The trials of rising tax rates in the future
- Understanding the amount of money to put away in a 401(k) plan or Roth IRA
- Being smart about your personal debt
- Diversifying your portfolio to mitigate the damage of a volatile market
- Insulating your income when the unexpected occurs
So, while the debt ceiling crisis is on the far end of the spectrum of economic disasters, it’s a welcome reminder to speak with your financial professional today. Make sure your financial plan is strong enough to weather the storm of the uncertain, the unplanned and the unexpected.