Investors’ Guide to the Debt Ceiling Debate

As a professional analyst of public policy issues, the forecasting of political events is a favorite topic.  My record has been good.

Despite this, whenever I write on these issues there is a danger.  I explain that this is analysis, but there is always a temptation to view the explanation as a politcal opinion.  It is not.  I can admire political strategy by skillful leaders who represent a different political viewpoint.  You should be able to do the same.  With this in mind, here is my summary of the current debt ceiling debate.


Congress has a (mostly symbolic) celing on the national debt.  Through decisions on appropriations and revenues the Congress participates in setting a budget that has regular deficits.  The debt limit is something of a fig leaf, but it does have the force of law.

No responsible official thinks that defaulting on debt is desirable.

  • Bernanke stated, "I think using the debt limit as a bargaining chip is quite risky."
  • Business leaders join in warning on the economic consequences.
  • Speaker Boehner drew sharp questions in his "tough" speech about the deficit problem.

Tea Party Influence

There is a significant effect from the "tea party" voters, and those elected by them.  Even the aggressive Republicans cannot do enough to satisfy this group. Here is a Fox News story explaining what is expected:

We're telling Boehner and all of the House Republicans, they came into office with Tea Party help. We now expect them to keep their promises and hold the ceiling on the national debt," said William Temple, head of this fall's Tea Party National Convention. "The Tea Party will not be in a very forgiving mood this fall, nor as the GOP primary season opens, if House freshmen and others elected by the Tea Party cave to Obama. We will find replacements for them this fall.

What it All Means (and how to profit)

The typical pundit commentary on Congress is fun to write and resonates strongly with readers.  The theory is that every representative should be like Jimmy Stewart in Mr. Smith Goes to Washington, acting on principle and ignoring political pressure.

Mr. smith

The problem is that one person's principle is another one's poison!

The debt limit saga will play out according to the following playbook:

  1. The debt limit will be raised;
  2. All participants will play out the string, demonstrating to supporters that they did their best;
  3. The final resolution will include a commitment to deficit reduction, with some combination of tax increases and spending cuts .

Any scares based upon the debt ceiling issue are buying opportunities for long-term investors.  I see the discussion as a predictable political sideshow.  It is really business as usual.

[Update: slip on "tax cuts" fixed.]

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  • SE Fest May 12, 2011  

    Your grammar and your analysis are equally horrible… What should we do? Buy the dip when the rhetoric rattles markets? Very insightful.

  • oldprof May 12, 2011  

    Heh heh —
    As I said, it is difficult to do analysis without drawing mindless bozos who have a political viewpoint.
    I welcome disagreement and discussion, but this anonymous troll needs to bring some game before we can even consider the comment.

  • Jeff May 13, 2011  

    I can empathize with what SE Fest is feeling about your article. This article is not up to your usual standards.
    What do you mean by “with some combination of tax cuts and spending”? Did you really mean to say tax increases and spending cuts?
    Predicting a debt limit increase is slam dunk obvious. Your predictions are wishy washy.
    And your article doesn’t even address the most interesting questions:
    1. When will the debt limit be raised?: next week?, by end of May, June, July, or August?
    2. By how much will the debt limit be raised?
    3. Approximately how much in spending cuts will be included with the debt limit raise?
    4. Appoximately how much in tax increases will be included with the debt limit raise?
    Address these somewhat difficult and interesting questions, and then answer them correctly. Then you will deserve some credit for political insight.

  • oldprof May 13, 2011  

    Jeff – Thanks for catching the slip on “tax cuts.”
    Sorry you did not like the article. It is important to stick to what can be actually be predicted, and that is what I do. My forecasts, however modest you find them to be, differ significantly from what we hear every day on the news. While your list of questions is interesting for those of us closely following the issue, I don’t think the answers have much investment significance. By contrast, the conclusion that despite the political brinksmanship there will be a resolution is something the investor can use.
    For you and other readers who have this all figured out on your own, I congratulate you. Since I get regular questions on this topic, I know that many others are not so confident.
    Thanks for joining in.

  • Angel Martin May 14, 2011  

    Jeff, I agree with you that eventually the Republicans will cave and the debt ceiling will be raised. But I think there is a significant probability of a wreck before that, and current Intrade prices seem to agree.
    One point you made that I don’t agree with, in my view the Republicans will never agree to any tax increases.

  • Angel Martin May 14, 2011  

    Jeff, I also wanted to add, if there is a short term period where the Treasury can’t meet all it’s obligations and has to delay payment (and perhaps do some asset sales) what would you expect the stock, corporates, foreign exchange and treasury markets to do?