The Imminent Threat Of Uncle Sam’s Debt Ceiling Problem

Jasmine Jade Pitman

What is the U.S. debt ceiling?

The U.S. debt ceiling was put in place by the Second Liberty Bond Act in 1917, it is explicated as the total amount of money that the United States government is authorized to borrow, essentially a cap on issuance of bonds. This debt limit allows the government to finance existing legal obligations that have been made but does not permit new spending commitments. Notionally, the debt ceiling is a means to keep the government from expanding unchecked and prompts it to act financially responsible.

The U.S. is considered a ‘safety haven’ for investors across the world as government bonds are deemed risk-free. In the past, the debt ceiling has been raised whenever the United States has impended the limit. Failure to raise the limit would decrease its credit rating from S&P (and other rating companies), causing detrimental effects (expanded on below).

The current debt limit is $ 31.4 trillion, and the U.S. hit this limit on the 18th of January 2023 - in order to keep the economy functioning after this limit was reached, the treasury has taken ‘extraordinary measures’ by shifting around funds. However, this can only last for so long.

What happens in a default?

A default would simply be defined as the inability to repay the country’s debt. Raising or defaulting on the debt is a political issue which is ultimately decided by Congress. Raising this limit would allow the government to increase its borrowing to cover spending already approved by Congress. Contrastingly, failure to raise the ceiling would cause the government to default in paying back its debts. The U.S has never defaulted on its debt ceiling; Congress has always acted when called upon to raise the limit. Hitting the debt ceiling isn’t the predominant problem, it’s only the beginning before the principal disaster strikes – a default. It is estimated that this default will occur between July and December 2023 (dependent on forthcoming tax revenues). Simply put, once the debt limit is reached, the Treasury cannot sell any more bonds or other securities to pay off the debt.

Defaulting on the debt limit could be said to have catastrophic effects; the treasury would be unable to pay federal money towards expenditures such as, Medicare, social security, defense salaries and coupons for bond holders. Subsequently, the U.S. credit rating would most certainly be degraded, causing interest rates to rise, and making loans more expensive. These higher interest rates would cause businesses to decrease their borrowing, leading to less opportunity for expansion and less hiring of workers, reducing demand.

As consumers spend less money, businesses may lower prices which means they consequently make less profit. When that happens, there’s a risk of layoffs, which could lead to a recession. This would send shock waves through global financial markets, ensuing a fall in confidence amongst U.S. borrowers. The consequent effect on the stock market would cause plummets across the globe, volatility spikes and would unnerve the financial markets.

How can the debt limit be reduced?

In the case of a default, contractionary fiscal policy may occur which involves raising taxes and reducing government expenditure. These effects however can impede on living standards and slow economic growth. Furthermore, this process could be viewed as rather cyclical as if the government reduces expenditure, the revenue in turn is also likely to decrease, which can lead to a larger deficit.

How likely is a debt default?

How does this affect YOU?

When the debt ceiling is reached, your standard of living could be affected; interest rates may increase, hindering economic growth. The increasingly falling investor confidence could mean lower returns on investments, making a recession possible. It also places pressure on the country’s currency because its value is tied to the value of the country’s bonds. As the value of the currency declines, foreign bond holders› repayments are worth less and goods and services may become more expensive, which contributes to inflation. This will increase prices, which leads to a decrease in purchasing power amongst consumers. In the likely case that salaries don’t increase proportionally with inflation levels, this will cause all consumers to be worse off.

Further Reading: https://www.washingtonpost.com/business/2023/05/01/congress-debt-limit-deadline-biden-mccarthy/ https://www.cfr.org/backgrounder/what-happens-when-us-hits-itsdebt-ceiling https://www.whitehouse.gov/cea/written-materials/2023/05/03/ debt-ceiling-scenarios/

Regardless of the ongoing political brinkmanship over the debt ceiling measures, it is said to remain unlikely that the U.S. will default on its debts; the ceiling has been revised 78 separate times since 1960. Furthermore, President Biden has already made deals back in 2021 with Republicans to pass critical legislation, most notably the $ 1.2 trillion infrastructure package. Therefore, it’s likely that he will be able to negotiate spending reduction measures in exchange for raising the debt ceiling.

Key Words:

Debt limit / ceiling - the total amount of money that the United States government is authorized to borrow Default – the failure to make required interest or principal repayments on debt.

Interest rates – defined as the cost of borrowing money and the reward for saving.

Contractionary fiscal policy – targets a reduction in demand (increased taxation and reduction in government expenditure).