With the U.S. potentially facing a default on debt as soon as June 1, Congress is running out of time.
While Democrats and Republicans are as polarized on this issue as ever, no one should want the U.S. to default on its debt, said Steve Wyett, BOK Financial® chief investment strategist.
“It’s a self-inflicted, really bad outcome if we get to a point where the federal government cannot borrow any money and doesn’t have money to send to bondholders. That would be a technical default,” he said.
“Just as importantly, there are so many people who rely on government payments to be able to live,” he said. “If there’s a delay that goes on a week or longer, there will be significant economic impact. Both sides are right that we should do everything we can to avoid that.”
Wyett believes that, as they have before, both sides will come together at the 11th hour to resolve the issue before a default occurs. But looking down the road, the current rate of government spending and debt accumulation may have serious consequences, and all of the solutions proposed in Congress have both pros and cons.
Here’s what may lie ahead, according to Wyett.
Broadly speaking, what are the two polar views on the current situation?
There are some who think that the increase in the annual budget deficit that the Congressional Budget Office has forecast is sustainable and not necessarily a problem, and so any spending cuts or review of the way we’re spending our money is unnecessary, Wyett said.
“And then you've got another side that says, if we’re going to keep spending this much and you’re talking about having to raise revenue taxes to the degree that reduces the deficit going forward, that’s a little bit untenable.
“Both sides are kind of in this position where, whether it’s spending cuts or revenue enhancements, there are some who are pretty entrenched,” he explained.
“The implication for our federal government is, if its debt or interest rate keeps going up, it could become way more expensive to fund that debt.”- Steve Wyett, chief investment strategist, BOK Financial
How much government spending is actually discretionary?
In the 2024 fiscal year budget, 61% of it is mandatory spending—that is, required by law. This “bucket” includes federal programs such as Social Security, Medicare and Medicaid. The remaining 39% is discretionary, meaning that it must go through the Congressional appropriation process annually, but a majority of that portion can only be cut so much.
“The biggest discretionary line item is defense spending. We’re sending a lot of arms to Ukraine. We’re going to have to rebuild that stockpile, and the geopolitical risks in the world appear to be increasing, not decreasing. At best, defense stays the same, but in all probability it’s going higher,” Wyett explained.
“The next biggest line item is interest expense, which is also going up because interest rates are higher than they have been. As this lower yielding debt that was issued over a year ago (when interest rates were at or near-zero) matures, we’re looking at higher interest expense over the next few years.”
That leaves only about 16% of the budget, which includes the Departments of Labor and Education, and programs like TSA. Cutting in those departments isn’t going to make a meaningful dent, Wyett said. And leaders in those areas are working to avoid having their budgets cut to avoid laying off workers and cutting back on services.
“I get it. Cutting spending is hard,” he said.
Can’t we just keep raising the debt ceiling?
On the flipside, maintaining government spending at its current rate could also have repercussions down the road—including less flexibility to handle another major economic disruption like the pandemic, if one should happen, Wyett said.
The situation is like with any debt, he noted. “The people who are willing to continue to lend you money will start demanding a higher interest rate because you’re riskier than you were before. And so, the implication for our federal government is, if its debt or interest rates keep going up, it could become way more expensive to fund that debt.”
However, Wyett cautions against heeding to doom-and-gloom assessments of what’s to come. “We’re not talking about failure. We’re talking about degrees of success,” he said. “We’ve been putting ourselves in a position where the level of success that we can expect in the future is less than what it could be.”