What’s the Deal with the Debt Ceiling? 5 Questions Answered

By Steven Pressman, Colorado State University, The Conversation

Ceilings are overrated. AP Photo/J. Scott Applewhite

Editor’s note: The U.S. government maxed out its credit card in March and has been moving money around ever since to avoid running out of cash. But very soon we will reach the limits of this financial sleight of hand, and Congress will have to either raise the debt ceiling – currently about US$19.8 trillion – or suffer the consequences. Economist Steve Pressman explains why we have a ceiling and why it’s time to get rid of it.

1. What is the debt ceiling?

Just like the rest of us, governments must borrow when they spend more money than they receive. They do so by issuing a bond or IOU with a promise to repay and make regular interest payments. Government debt is the total sum of all this borrowed money.

The debt ceiling, which Congress established a century ago, is the maximum amount the government can borrow. In other words, it’s the limit on the national credit card.

2. How much has the US government borrowed and from whom?

Currently, U.S. government debt is $19.8 trillion, a tad more than the size of our economy.

Around one-third of this money the government actually owes itself. The Social Security Administration, which has accumulated a surplus since it was first set up in the 1930s, has invested all of this extra money in government bonds and currently owns $5 trillion worth. Separately, the Federal Reserve holds about $2.5 trillion in U.S. Treasuries.

The rest is considered public debt. As of March, foreign countries, companies and individuals own $6 trillion of U.S. government debt. Japan and China are the largest holders with $1.1 trillion each. The rest is owed to U.S. citizens and businesses, as well as state and local governments.


3. Why is there a debt ceiling?

Before 1917, Congress would authorize the government to borrow a fixed sum of money for a specified term. When each loan expired, the government could not borrow again until authorized to do so.

That changed with the Second Liberty Bond Act of 1917, which created the debt ceiling. This allowed for a continual rollover of debt without congressional approval of every loan.

Congress approved this measure because it enabled then-President Woodrow Wilson to spend the money he deemed necessary to fight World War I without waiting for often-absent lawmakers to act. Congress, however, did not want to write the president a blank check, so it limited borrowing to $11.5 billion, requiring legislation for any increase.

During the subsequent century, the debt ceiling has been increased many times, including 78 since 1960 alone. The last change occurred in March 2015, when Congress decided to suspend the limit for two years. When that legislation expired on March 16, 2017, U.S. debt stood at $19.8 trillion, which became the new limit.


4. How has the government paid its bills since then without incurring new debt?

The U.S. government generally spends more than it takes in ($440 billion more in fiscal year 2017), yet since March 16 it can no longer borrow more money to make up the difference. It can spend only cash on hand. As a result, Treasury Secretary Steven Mnuchin has used “extraordinary measures” to conserve cash.

For example, he stopped funding retirement programs for government employees so the money can be used to meet other obligations without breaching the debt limit. The expectation is that once the debt ceiling is raised, the government will make up for underfunding employees’ plans.

These measures, along with the annual surge in tax payments in April that gave the federal government a $182 billion surplus for that month, have enabled the government to pay its other bills. As of July 17, the Treasury had $201.4 billion in cash.

But it is not clear how long this money will last. Expenditures and revenues fluctuate considerably, and $200 billion can disappear in weeks.

The Bipartisan Policy Center and the Congressional Budget Office estimate that the U.S. will run out during the first two weeks of October, although they warn the country’s coffers could be empty earlier. With Congress scheduled to take a recess in August through Labor Day, something must be done soon.

When the cash is gone, decisions will have to be made about who gets paid and who doesn’t. Government employees or contractors may not get paid in full. Loans to small businesses, exporters or college students may stop. These actions will all lower spending and slow economic growth.

One difficult choice would be whether to prioritize foreign owners of our debt or first honor domestic obligations (including American bondholders). Some argue we’re legally obligated to pay all debt holders first, or that doing this is more important than paying other bills, but most people contend that all creditors need to be treated equally.

Some pundits have claimed that a government default would have dire economic consequences – soaring interest rates, markets in panic and an economic depression. But such fears are overblown, not because an actual default wouldn’t be catastrophic, but because once markets start panicking, Congress would likely end the game of chicken they are playing with the debt ceiling – just as it did in 2013. And even if it technically defaulted, the immediate turmoil would be so severe that Congress would swiftly act to reverse the damage.

Mnuchin has said he has “plans and backup plans” to find cash and enable the government to pay its bills, for at least a little while longer. For example, the U.S. could sell off some of its $11 billion in gold or even shut down temporarily, which it also did in 2013.

We could always sell some of the gold at Fort Knox, though $11 billion wouldn’t get us very far. AP Photo/Barry Thumma

This would buy Congress a little more time to act – or react to the plunging stock market that results. That’s what happened in August 2011 when Standard & Poor’s downgraded Uncle Sam’s AAA credit rating for the first time ever after brinkmanship over the debt ceiling. Congress quickly caved and raised it.

I expect the same to happen this year. Some Republicans will want to hold the line on spending, while Democrats (required to overcome a filibuster in the Senate) will likely push for more. In the end, they’ll do what they always do – perhaps after Wall Street gives them a push – and kick the can a few more miles down the road.

5. Is there a better way to deal with our debt?

The U.S. is one of very few countries with a debt ceiling. Other governments operate effectively without it.

We can too. Having a debt ceiling is actually dysfunctional. It makes it harder for the Treasury to pay bills when they come due.

The best solution would be to just scrap the ceiling. Congress already approved the spending and the tax laws that require more debt; it shouldn’t have to approve the additional borrowing as well.

It is also worth remembering that the original debt ceiling was put in place because Congress could not meet quickly and approve any needed spending to fight a war. In 1917, when cross-country travel was by rail, requiring days to get to Washington, this made some sense. Today, not so much.

Steven Pressman, Professor of Economics, Colorado State University

This article is republished from The Conversation under a Creative Commons license. Read the original article.

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