It’s been all over the news how we hit the U.S. debt ceiling. They make it sound like the sky is falling, like Armageddon is around the corner. But is it true? What does it even mean to hit the debt ceiling?
What is the debt ceiling?
Let’s start at the beginning… What is the debt ceiling? In
1917, Congress passed the Second Liberty Bond Act, which allowed the U.S.
Treasury to issue debt without Congress needing to approve each item of debt as
long as the U.S. Treasury stayed below the aggregate amount of debt that
Congress approved. That approved amount is the debt ceiling.
The U.S. Treasury uses debt to fund expenses that Congress already approved, but that exceed current tax and other revenues. In general, only 80% of government spending is covered by tax and other revenues, with the remaining 20% covered by steadily increasing debt.
So, this means that Congress has already approved 20% more spending on an everyday basis than can be supported with tax and other revenues.
How much is the debt ceiling?
Until 1982, the debt ceiling was below $5 trillion – and often far below $5 trillion.
From 1982 to 2002, the debt ceiling was below $10 trillion.
Since 2002, the debt ceiling has soared to over $31 trillion!
Today, the amount of U.S. debt represents about $94,000 for every person in the U.S. – every baby, child, college student, adult, and senior citizen!
Just to be clear – the debt ceiling needs to be raised just to service the expenditures ALREADY approved by Congress – it doesn’t even address any “new” spending.
To compare the debt ceiling with our “consumer” lives, the debt ceiling is our credit card limit – and we are maxed-out. However, we already signed contracts promising to pay more in the future than we earn, so what can we do? As individuals, we would face some really hard choices, but the U.S. government will appeal to Congress to raise the debt ceiling so they can continue to spend more than the U.S. government raises in revenue.
On January 19, 2023, the United States reached the debt ceiling (again) – meaning the government cannot issue more debt without Congress approving an increase in the debt ceiling.
So, what happens when the U.S. debt ceiling is reached?
So, what happens now?
First, this is NOT unprecedented. The U.S. has hit the debt ceiling many times before – like 20+ times since 1977! Just last year, in December of 2021, the debt ceiling was raised by $2.5 trillion. Sometimes the debt ceiling increase was simple and uncontroversial; other times it was a bloody congressional battle…this time, due to deep partisanship, it is likely to be the latter.
On Thursday, January 19th, 2023, Treasury Secretary Janet Yellen sent a letter to various members of Congress informing them that the debt limit was reached and that “extraordinary measures” would be taken to keep the Treasury solvent through early June. These extraordinary measures include delaying certain retirement investments; these investments will be made up later when the debt ceiling is raised. (Never in history has the debt ceiling NOT been raised.)
Secretary Yellen’s letter indicates that through early June of 2023, reaching the debt ceiling limit will probably not affect any payments to employees, U.S. treasury bill and bond holders, U.S. contractors, or anyone, really. The U.S. Treasury has always placed a priority on debt payments.
However, only 80% of committed payments are covered by tax receipts and other income, so 20% of U.S. federal spending is “paid” with new debt – which necessitates regular increases to the federal debt limit. The federal government operates at a deficit every day.
However, it is important to note that raising the debt ceiling does NOT authorize additional spending – it only facilitates spending that Congress has already approved. Discussions about new spending are fundamentally separate from discussions about raising the debt limit. However, a discussion on one point can be held hostage to the discussion of the other point.
What if Congress does not raise the debt ceiling by June?
Well, if the debt ceiling is not increased by June of 2023, the “extraordinary circumstances” can escalate into a “government shutdown”. There have been 10 government shutdowns since 1977; the last one was 34 days long in 2018-2019. But even a government shutdown is NOT the same as a debt default.
In a government shutdown, the government only funds essential services, which it can cover with tax and other revenue. A government shutdown allows the government to preserve cash for urgent government services while allowing certain less urgent government services to be temporarily discontinued. However, this is when some employees will be furloughed without pay.
And, because of partisanship, a government shutdown in June is definitely not out of the realm of possibility.
But, let’s NOT fear-monger, it has NEVER happened that social security was not paid. It has NEVER happened that U.S. treasury bills and bonds were not paid interest and principal. It has NEVER happened that the U.S. did not pay its debts.
Ok, but what is the “nuclear option” of not raising the debt ceiling?
The nuclear option is that the U.S defaults on its debt in June.
This has NEVER happened before. U.S. Treasuries are considered “risk-free” investments for a reason. U.S. treasuries are the most liquid market in the world and “flight to quality” has always referred to moving to U.S. Treasury investments during the most volatile times (like now). All of this is based on the U.S. maintaining its “full faith in credit.” Once, in 2011, the United States’ “full faith in credit” was called into question and the S&P Global Ratings downgraded the U.S. government’s debt from its AAA rating.
What happened then? Uncertainty increased, resulting in:
- Dramatic increases in U.S borrowing costs (and everyone else)
- Decreases in investor confidence
- Market declines
- Decreases in retirement account balances
However, while a government shutdown in June is a definite possibility, a U.S. default on its debt is not really keeping me up at night.
First, the government does not want its credit rating downgraded again (as it was in 2011),
Second, the government does not want to further increase its borrowing costs,
Third, the government does not want to create wide-spread financial panic and turmoil,
Fourth, if the United States ever went bankrupt, the U.S. and the world would have much bigger problems!
Last, while partisan differences exist, who in Congress or the Administration wants to go down in history as the one who took down the American economy and the global financial markets?
