What is the Debt Ceiling?

If you follow the news, you may have seen the term "debt ceiling" thrown around in the past few months. But what does this mean?

A Historical Look

The debt ceiling was created by congress during the first World War to hold the government accountable for its spending. When the limit is reached, the US goes into default, which has a negative impact on the nation's debt and credit rating. Most other democratic countries do not have a debt ceiling, so this is something that's rather unique to the US government. This ceiling provides a more streamlined process to issue and approve bonds, allows the government to manage available funds more easily, and keeps programs like Medicare up and running.

Although, there are some concerns over the use of the debt ceiling, including an argument over whether or not it's constitutional. Additionally, the debt ceiling can be raised easily, making the "limit" more flexible than it was designed to be. Since its creation, the limit has been altered numerous times for various reasons. On many occasions, the debt ceiling was raised once the limit was reached, allowing for more spending, and preventing default. But, these increases have put the US in record levels of debt, and frequently cause discussions of government shutdowns.

Why it Matters

What is the importance of the debt ceiling? Today, the debt ceiling is crucial in determining the current state of the economy, as well as how it might look in the near future. The phrase seems to always be in the news, posing questions on the state of the country's economic health. Most recently, the debt ceiling was suspended until 2025 after months of deliberation. This followed the limit being reached in January 2023. Before the crisis ended with the enactment of the Fiscal Responsibility Act, the federal government was on the verge of default, and at the time, it was feared that this would result in economic catastrophe on a global level. So, not only would a default negatively impact the US economy, including both the average citizen and federal government alike, but economies across the world, as the US is a huge player in the global financial network.

Understanding the Impact

When issues of the debt ceiling arise, investors should pay attention. If the government defaults on its debt, the financial sector would take a huge hit, and stock prices would fall across the board. This can also lead to layoffs and potential long-term economic consequences, making it difficult to come back from. Even so, this doesn't even begin to tackle the international implications of a default, which would cause even further issues.

These are only a few of the many reasons why a diversified portfolio is crucial for investors. No matter what your risk tolerance is, it will always be in your best interest to have a variety of stocks, ETFs, or other products in your portfolio to hedge against potential losses. Additionally, keeping tabs on the news and rebalancing your portfolio every now and then can allow you to stay aware of what's going on in the finance world and adapt as needed. The last thing you want is to take unnecessary losses, and keeping up with your investments, as well as what's going on with the economy, can help you be as prepared as possible for whatever may come your way.

However, it's always important to remember that the market is unpredictable, so even the most prepared investors risk losses when they trade. The only thing you can do is understand your risk level, have a strategy in place, and do your best to avoid emotional trading.

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