The government shutdown may have ended last week, but a much bigger crisis is fast approaching. The debt ceiling comes back on March 1, requiring Congress to act immediately to avoid a fallout that could threaten the United States’ credit rating.
While Wall Street slid through the 35-day shutdown relatively unscathed – stocks even rallied about 10% during it – the shutdown potentially slowed economic growth. One White House economist even predicted GDP growth fell to 0% during the month-long shutdown.
However, the shutdown’s economic toll is small change compared to the fiscal disaster that’s lurking just around the corner.
You see, the U.S. government is only three weeks away from hitting the federal borrowing limit – a congressionally set limit on how much money the government is allowed to borrow.
If congress fails to raise the debt ceiling by March 1, it will trigger three devastating consequences that that will rock the global economy.
And it could devastate your portfolio for years to come if you aren’t prepared…
Hitting the Debt Ceiling will Destroy the Nation’s Credit Rating
One of first things that will happen if the United States hits the debt ceiling is the government won’t be able to issue new Treasury bonds.
The United States Treasury Department sells bonds to raise money for the government. In return, buyers receive regular interest payments on the bond until the date of maturation. And the United States pays this interest so reliably that U.S. bonds are considered so safe and reliable that investors park billions of dollars into them each year.
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But if the United States loses its ability to borrow more money, it won’t have enough cash to meet all of its financial obligations. That could affect bond payments too, which would destroy the U.S.’s sterling AAA credit rating.
If the United States can’t make its treasury bond payments, international credit rating agencies like Moody’s Co. (NYSE: MCO) will be forced to downgrade the nation’s credit rating. U.S. treasury bonds will be considered a riskier investment overnight.
And that’s terrible news for Wall Street.
You see, a lower credit rating is likely to push the nation’s interest rates higher. In order to attract buyers for Treasury bonds, the United States will have to promise an even higher interest rate in exchange for the risk. Mexico, for instance, pays an average rate of 8.93% on its long-term bonds, while the United States’ average is just 2.7%.
These higher-interest payments are likely to trickle down into the nation’s economy, burning investors in the process.
As we’ve seen over the last year, higher interest rates are an Achilles heel for stocks. That’s because investors respond poorly to higher interest rates since it’s costlier for businesses to finance growth.
And that shrinks company bottom lines – and shareholder returns.
However, higher interest rates are only one part of this perfect storm…
The Debt Ceiling Will Tank the U.S. Dollar
In addition to driving interest rates through the roof, a national credit default will cause the U.S. dollar to drop like a rock.
The American dollar is held as the world’s top reserve currency due to its reputation for stable value.
In fact, as of 2017, 62.7% of the world’s reserve currencies are in U.S. dollars.
However, a credit default is likely to rattle international confidence in the dollar’s ability to maintain its value.
If foreign nations lose faith in the stability of the American dollar, they’re likely to reduce their reserves, flooding international markets with American currency.
The more dollars there are in general circulation, the less valuable they are. As a result, their buying power falls and inflation begins to rise.
Wall Street treats inflation as a significant threat because it shrinks shareholder returns as businesses are forced to spend more money and raise prices.
While both higher interest rates and higher inflation will put 2019’s returns in jeopardy, there’s one last factor that could eliminate returns for years to come…
The Debt Ceiling Will Devastate the Nation’s GDP
If inflation and higher interest rates weren’t enough, hitting the debt ceiling is almost certain to erode the nation’s gross domestic product.
During last month’s government shutdown, 1.6 million paychecks were withheld from 800,000 government employees.
According to the CBO, the government’s inability to deliver these paychecks cut an estimated $3 billion of the nation’s annual GDP in just 35 days.
But a debt ceiling crisis could result in even more drastic spending cuts. Medicare, Medicaid, Social Security, Veterans Affairs, military pay, and interest on debt could potentially be affected. The United States does not take in enough money in tax receipts each month to pay for all of these expenses.
This kind of collapse will make GDP fallout from the longest shutdown in American history look like child’s play – the impact will be magnitudes larger on the national economy.
Now, while the United States has never defaulted on its debt, it’s gotten close over the last decade. Now we have a divided Congress and a polarizing president, which could make a deal extending the debt ceiling even more difficult.
With animosity in Washington reaching a fever pitch, we can expect either the White House or Congress to take the debt ceiling hostage in an attempt to force the opposition’s hand on border security or healthcare spending.
In short, a political battle down to the line on the nation’s debt ceiling is all but certain, and a full default is more likely by the day.
But that doesn’t mean you can’t be prepared for when the worst of it comes. In fact, you could even profit when the debt catastrophe hits…
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