Understanding the US Debt Ceiling
NEWS ALERT: U.S. Could Default as Soon as July if Debt-Ceiling Standoff Isn’t Resolved (The Wall Street Journal, February 15, 2023)
What is the US Debt Ceiling?
The US debt ceiling is a legislative limit on the amount of national debt that the federal government can accumulate. When the government reaches this limit, it can no longer borrow money to finance its operations and must negotiate a debt ceiling increase with Congress.
The debt ceiling negotiation process involves talks between the President, members of Congress, and other stakeholders to reach an agreement on an increase in the debt limit. The negotiations often become politically charged, as both political parties have used the debt ceiling as leverage by to push for other policy priorities.
The risk to the financial system arises if the debt ceiling is not raised in a timely manner and the government is unable to pay its bills. This could result in a default on its debt, which would no doubt ignite a financial crisis and potentially lead to a sharp decline in the value of the US dollar and other financial assets. Furthermore, a failure to raise the debt ceiling could cause widespread financial uncertainty and increase interest rates, which would trigger a recession in the US and beyond.
What was the original purpose of the US Debt Ceiling?
The original purpose of the US debt ceiling was to give Congress greater control over government spending and borrowing. The first debt ceiling was established in 1917, as the US entered World War I and needed to finance the war effort. The debt ceiling was seen as a way for Congress to exert greater control over government spending, as it required approval from Congress before the government could increase its debt.
Over time, the debt ceiling has become a more formalized process and is now an established part of US fiscal policy. The debt ceiling is seen as a tool for controlling government debt, as it requires Congress regularly to review and approve any increases in the national debt.
In addition, the debt ceiling has become a recurring political issue, as it has been used as leverage by both political parties to push for other policy priorities. The debt ceiling negotiation process can be politically charged and has resulted in government shutdowns and financial uncertainty in the past.
When will the US reach the debt ceiling?
The debt ceiling is suspended until July 31, 2023. This means that the federal government can continue to borrow money to finance its operations until that date. After July 31, 2023, the debt ceiling will be reset to the level of the national debt at that time and will become a legally binding limit on the government's borrowing.
It is impossible to predict exactly when the debt ceiling will be reached, as it will depend on a variety of factors, including the level of government spending, the state of the economy, and other fiscal and monetary policies. However, it is likely that the debt ceiling will need to be raised soon, as the national debt is projected to continue to increase in the coming years.
It's important to note that the debt ceiling is a political construct and not a reflection of the government's ability to repay its debt. The government can continue to service its debt even if it reaches the debt ceiling, but it may have to prioritize debt payments over other expenses, including such politically sensitive items as Social Security, Medicare, and defense spending. Such actions would not be uncontroversial, as some commentators characterize them as the government remaining current on its debts but defaulting on its obligations.
Has the US ever defaulted on its debt?
No, the United States has never defaulted on its debt. The US has a long history of repaying its debts on time and in full, which has helped to establish the US Treasury bonds as a safe and secure investment.
However, there have been instances in the past where the government has come close to defaulting on its debt. For example, in 2011, a political standoff over the debt ceiling led to a partial government shutdown and a downgrade of the US credit rating. In 2013, a similar standoff resulted in another partial government shutdown.
These incidents demonstrate the importance of raising the debt ceiling in a timely manner to avoid the risk of default and maintain the government's ability to finance its operations. By avoiding default, the US can maintain its reputation as a reliable borrower and keep its borrowing costs low, which benefits the government and the broader economy.
What Are the Issues in the Current Negotiations?
House Republicans are demanding spending cuts in exchange for agreeing to raise the debt ceiling. Democrats have charged that the Republicans have not been specific about where they want to cut, presumably due to differences within the Republican caucus. For example, some Republican members have advocated trimming Medicare benefits or increasing the age for receiving Social Security benefits in order to reduce future outlays. Those are more politically charged proposals than the Republican leadership may be willing to push.
If negotiations fail to progress, a strange-sounding solution may begin to get serious consideration. While the amount of issuance of paper currency is limited by law, no such restriction applies to platinum coinage. During the 2011 debt ceiling crisis the idea emerged that the government could bypass the debt ceiling by issuing a trillion-dollar platinum coin. The Federal Reserve and Treasury rejected the mechanism, but the concept reemerged in 2021 and has begun to surface during the current crisis.
What Is the Most Likely Outcome?
We do not expect that US to default on its debt. The January rally in stocks suggests that the market does not, either. In addition, the leading credit rating agencies have not altered their views on the government’s ability and willingness to continue meeting its debt obligations. Note, however, that there is a risk of severe disruption of the financial markets as the point at which the debt ceiling will be reached gets closer.