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Financial Wisdom

"An education isn't how much you have committed to memory, or even how much you know. It's being able to differentiate between what you do know and what you don't."
Anatole France (1844 - 1924)

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Posted on 7/23/2011 10:36:35 AM

Much of the news has been focused on the debt ceiling and the ongoing discussions between the Obama administration and members of Congress. While it’s easy to ignore this and chalk it up to “politics as usual,” there is good reason for each of us to pay attention and understand the implications of these conversations.


What is the debt ceiling?

First, let’s start with a brief definition of what the debt ceiling is. Think of the debt ceiling as a line of credit for our nation. Congress set a law many years ago on how much debt we could incur as a nation (this has changed many times historically). The debt ceiling is currently set at $14.3 trillion. That’s a lot of zeroes and hard for most of us to fathom.


We incur debt because our government is not taking in (via taxes) enough to cover our spending. We’ve been doing this for many years and, unfortunately, no previous party or administration has been willing to take this on, for fear of not being re-elected.


How does our government incur debt?

When taking on debt, our government issues Treasury bonds, which many other countries buy. This debt is backed by the “full faith and credit of the United States Government,” which has historically been seen as a “low risk” or secure investment.


By increasing the “debt ceiling,” we would be borrowing (and issuing more bonds), yet again, increasing our national debt and extending our payback period to pay for current and past expenditures for things like Social Security, Medicare, Medicaid, education, military spending, etc.


Think of it as rolling your credit card debt and other personal debt into a loan to refinance your home. Refinancing will consolidate your debt, hopefully get you a lower interest rate and extend your payback period.


Increasing the debt ceiling would merely be an extension of time and does not reduce, but rather, increases our obligations. This strategy usually only works in the short-term (provided you know that you will have an increase in income or a decrease in debt—ideally both, in the NEAR future). As a long-term strategy this is unsustainable.


Fasten your seatbelts and hold on to your money

If U.S. citizens are earning less or are unemployed then we are paying less in taxes to our Government. This means there is less money to pay our country’s current and future debts, thus creating a downward spiral—meaning we incur even greater debt with even less ability to pay. This now becomes a self-perpetuating problem, with high inflation and a rapidly shrinking middle class—unless things change dramatically.


The world has always believed that our nation’s economy is strong so they continue to buy our bonds. As our economy and political will become less stable, this belief could change. Others may stop buying our bonds (lending us money) and ask for repayment. We would not be able to pay and therefore, would “default” on our obligations (much like defaulting on your home mortgage). Our currency would then be perceived as having less value (and greater risk), causing interest rates to rise dramatically, and inflation to kick in. It will be more expensive to “borrow” money because people or nations would want higher interest payments for taking greater risk (on our bonds).


When our dollar becomes “weaker” or less valuable, it also becomes less stable. The cost of everything goes up—from mortgages and food to fuel (gas, oil, etc.) and clothing and more—perhaps substantially.


For the average American, household incomes have gone down substantially since mid-2007, while the cost of practically everything has gone up. This downward trend is simply unsustainable if we want a vibrant economy and country.


A downgrade for U.S. bonds?

Because of the ongoing disagreement in Congress about whether or not to raise the debt ceiling, Moody’s (a rating agency) has suggested a downgrade to the U.S. bond rating, which is currently Aaa (meaning highly secure, from a risk perspective). Essentially, Moody’s is saying that the likelihood of our defaulting on a payment is no longer “out of the realm of possibility”—so much for our elected Federal officials playing Russian roulette with our lives. If this were to occur, the effect will reverberate around the globe. 



So, should you care about the debt ceiling? Definitely! What should you do with your money? Many are suggesting that you sit tight and ride this out. That seems to be the fallback advice a lot these days. I would certainly ask myself who benefits from this advice? Where would my money be most secure? The most secure options available currently are savings accounts, CDs, etc. (or even a coffee can).


Bottom line: Stay tuned in and pay attention to these conversations so you can be prepared for possible outcomes and protect your family and your life savings.


Do you have more questions about the debt ceiling? Share them with us!


Additional Reading:

News from the Congressional Budget Office (CBO), unbiased information on the impact of the U.S. debt in the short-term, mid-term and long-term 


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