- In May the White House and the Republican opposition were negotiating against the clock to raise the US debt ceiling.
- The Treasury warned it might run out of funds in early June.
- A default, though unlikely, would be a low-probability, high-impact risk: diversifying is the simple way to cushion surprises.
In May 2023, the White House and the Republican opposition were negotiating against the clock to raise the US debt ceiling, while the Treasury warned that it could run out of funds in early June. The issue had gone from being a technical formality to one of the focal points of market attention.
For anyone who does not follow US politics, it may seem surprising that a country has to vote in order to pay for what it has already spent. But that is how its system works, and that is precisely why these episodes create tension: a political decision determines whether the issuer of the debt considered safest in the world can meet its commitments. Although most analysts considered an actual default unlikely, the mere fact that it was openly discussed forced companies, banks and investors to ask what consequences it would have and how exposed they were to them.
What the debt ceiling is
It is the legal borrowing limit that Congress sets for the US government. When it is reached, the Treasury cannot keep borrowing to pay commitments already made, unless the ceiling is raised by a political vote. It is not about authorising new spending, but about being able to finance what has already been approved.
Until it is resolved, the Treasury can resort to extraordinary accounting measures to buy time, but these have a limit. Hence the talk of a date on which funds might run out: from that moment, the government would have to decide which payments to make and which not, a situation nobody wants. The ceiling figure has been changed many times over the years, and each occasion has been resolved with agreements that, more than a judgement on the level of debt, reflect the political balance of the moment.
A negotiation against the clock
With the June date drawing ever closer, the political stand-off was played out against the clock, and any news from the negotiation showed up in prices. Such episodes are usually resolved at the last moment, but every time they occur they make markets nervous.
The nervousness shows up in price movements and in greater interest in assets seen as safe havens. Although most observers expected an agreement, uncertainty about the timetable and the content was enough for the situation to be followed closely all over the world, including from Europe. For a company with operations in the United States, or with investments and cash denominated in dollars, the episode was a reminder of the importance of knowing in which instruments and with what maturities those funds are held.
A low-probability risk
A US default, though unlikely, would have shaken the entire financial system. It is a good example of a low-probability, high-impact risk worth keeping in mind. US debt acts as a reference for valuing almost every other asset, so any doubt about it is transmitted to the whole market.
For the prudent investor, the lesson is that diversifying and not concentrating wealth in a single asset or issuer is a simple way to cushion surprises. This does not mean predicting what will happen, but accepting that some risks cannot be eliminated and structuring the portfolio so that no isolated event is decisive. It is worth discussing with the adviser. It is also worth distinguishing between the risk of an issuer failing to pay and that of its market price fluctuating: they are different things, and confusing them sometimes leads to hasty decisions in the face of alarming headlines.
Unlikely risks cannot be eliminated, but depending on just one can be avoided.
This article is general information. It is not legal, tax or investment advice, and it does not take anyone’s particular circumstances into account.
