The financial press often makes mention of the U.S debt ceiling, especially as that limit is about to be reached or breached. The headlines warn of an impending crisis if the U.S. were to default on its debts because the ceiling wasn’t increased enough or in time.
The debt ceiling explained
As U.S. debt increases, the Treasury Department has to borrow money to cover government spending commitments, but this amount is officially capped at a level known as the debt ceiling. It was established by Congress in 1917 and sets the maximum allowable amount of U.S. government or federal debt.
Congress must vote to suspend or raise the limit. Increasing the debt ceiling requires majority approval from both chambers of Congress — the Senate and the House of Representatives.
Failure to lift the cap could put the U.S. Treasury in the position of being unable to pay for spending approved by Congress. Economists warn of dire consequences, including default, if Congress is unable to reach an agreement on a new ceiling level.
Raising the ceiling
The debt ceiling needs to be raised any time the U.S. has insufficient funds on hand to repay its debts as they come due. Congress also has the option to suspend the debt ceiling, or temporarily allow the Treasury to exceed the limit.
For most of the past century, raising the ceiling was a routine exercise. When the Treasury Department was nearly unable to pay the government’s bills, Congress acted quickly and sometimes even unanimously, to increase the borrowing limit.
Since 1960, the debt ceiling has been increased seventy-nine times, most recently on June 8th, 2023. The Fiscal Responsibility Act of 2023 will see the debt ceiling raised until January 1st, 2025 and caps some federal spending for a couple years.
While suspensions were rare during the first ninety years of the ceiling’s existence, Congress has suspended the debt limit seven times since 2013.
What happens if the debt ceiling isn’t increased in time?
Congress has authorized so much new spending that the United States’ debt has almost tripled since 2009. During this period, the Treasury Department’s ability to borrow money to make their debt payments has repeatedly come up against the debt ceiling limit.
Possible repercussions of missed or late payments include a credit rating downgrade (as occurred in 2011), higher borrowing costs for businesses and individuals, as well as a sharp drop in consumer confidence that would shock financial markets and likely tip the economy into a recession.
If an agreement is not negotiated before the ceiling is reached, the Treasury can use temporary actions it calls “extraordinary measures” to stave off default, at least for a few months.
The U.S. federal government actually reached its $31.4 trillion borrowing limit on January 19th, 2023, prompting the Treasury Department to employ extraordinary measures to avoid default, which included emergency changes to some government accounts.
What happens if the U.S. defaults?
Built on decades of trust in the United States government, U.S. debt is considered extremely safe and the bedrock of global commerce. A default would disrupt the Treasury debt market, wreak havoc in global financial markets and trigger a global crisis.
Any adverse effect on confidence in the U.S. economy, whether from actual default or the uncertainty of it, would likely cause investors to sell U.S. Treasury Bonds and thus weaken the U.S. dollar along with its status as a global reserve currency.
This high-stakes political gamesmanship undermines the credibility of the U.S. government’s commitment to repay its debts. Even though very few creditors would doubt America’s capacity to pay, debt ceiling politics could cloud perceptions about their willingness to repay.
Debt ceilings outside the U.S.
Very few countries maintain debt ceilings, and nowhere else do they regularly threaten any sort of serious economic disruption. Denmark has one, but it’s so much higher than the country’s spending that it’s never posed a problem.
Meanwhile, the European Union, Poland, Pakistan, Malaysia, Kenya, and Namibia have their debt ceilings set as a percentage of gross domestic product (GDP).
Twenty-first century ushers in brinkmanship
Brinkmanship has become a real problem with regards to debt ceiling increases with opposition parties using the negotiations as leverage to influence unrelated policies or express discontent with deficit spending. And this will keep happening, as long as there’s leverage for use in negotiations.
But, it’s a dangerous political bargaining tool that holds the economy hostage while the opposition makes demands. For this reason, some think it’s time to get rid of the debt ceiling.
Doing away with the debt ceiling
Some of the greatest contributors to rising U.S. debt levels over the past 50 years include the wars in Iraq and Afghanistan, the 2008 financial crisis and the 2020 COVID-19 pandemic. And there will be more such events.
According to Massachusetts Senator Elizabeth Warren, “We should get rid of the debt ceiling. There’s no other function than to let hostage-takers ply their trade.” Congress could eliminate the debt ceiling entirely or make it so that the limit automatically increases whenever a new spending bill gets passed.
While there is growing support for abandoning this antiquated mechanism that brings the U.S. to the brink of default every few years, repealing the debt ceiling will be challenging. Only time will tell, but unless and until it changes, at least we can take comfort in the fact that the necessary actions eventually occur to avoid the worst case scenario.