Last month, January 19 to be exact, the U.S. reached the debt ceiling of $31.381 trillion. The debt ceiling is the cap on how much money the federal government is authorized to borrow to meet its obligations.
In the event, the U.S. could not meet its obligations (i.e., defaulting on its debt) some likely effects would be a spike in bond yields, higher borrowing costs, plummeting consumer confidence, and financial market turmoil and contagion. This may sound traumatic, and it would be, but Congress has raised or suspended the debt limit 79 times since 1960.
Voters and investors alike should recognize by now that the debt limit is as much a political tool used in regular negotiations as it is a means to running government. Republicans are holding firm that they will not sign any increase in the debt ceiling without spending cuts, while President Biden does not want to agree to any strings attached for fear of a shock to the economy.
With the Republicans holding a very narrow majority in the House of Representatives, and several Republicans saying they will not vote for a debt increase at all, it will likely require Democratic votes to pass an increase. Since 2011, House Republicans have largely opposed any debt ceiling hike, whereas Senate Democrats have been overwhelmingly in favor of them.
What Does Hitting the Debt Ceiling Mean?
Reaching the debt limit does not automatically trigger a default on U.S. debt as the Treasury can still use funds from the Treasury General Account (TGA) or implement “extraordinary measures” to continue to meet its obligations. Here’s the viability of using either of these options.
On January 19, the Treasury General Account stood at $456 billion. If this were not used, or used up, the “extraordinary measures” being considered include: redeeming investments in the Civil Service Retirement and Disability Fund (CSRDF) and the Postal Service Retiree Health Benefits Fund (PSRHBF) freeing up $8.4 billion, suspending reinvestment of the Government Securities Investment Fund (G Fund)– $294 billion, suspending reinvestment of the Exchange Stabilization Fund (ESF)– $17 billion, and suspending sales of State and Local Government Treasury securities– $143 billion. In total, the TGA balance and extraordinary measures could provide over $950 billion of relief.
Even with these extraordinary measures, the Congressional Budget Office predicts its funds would be exhausted sometime in the summer of 2023. “We project that, if the debt limit remains unchanged, the government’s ability to borrow using extraordinary measures will be exhausted between July and September 2023,” CBO director Phillip Swagel said earlier this month.
Facts to Worry, or Not Worry About
- The closest the U.S. came to defaulting on its debt was in 2011, in which a last-minute deal prevented such a debacle. Nevertheless, this caused the only credit downgrade of U.S. debt in history.
- U.S. Debt-to-GDP (Gross Domestic Product) averaged 65.20% from 1940-2022. In 2022, the ratio reached 129%, the highest in U.S. history. (Trading Economics- US Gross Federal Debt to GDP).
- Net interest payments on U.S. debt cost nearly $400 billion annually (Office of Management and Budget).
- Japan has the second most outstanding debt, $13.05 trillion, but its Debt-to-GDP ratio is by far the highest– 259%.
- China has the world’s second-largest economy, but just over $10 trillion of debt, representing only 68% of its GDP. (World Population Review- National Debt by Country).
If politicians fail to come to an agreement and actually did go over the debt cliff, the Federal Reserve would serve as the first line of defense. After coming dangerously close in 2011, the Fed came up with a game plan in which the central bank would purchase defaulted Treasuries, essentially paying off bondholders.
Transcripts from the FOMC meeting in August 2011, specified that “so long as the default reflects a political impasse and not any underlying inability of the United States to meet its obligations.” This Plan B is reassuring, so long as “political impasse” never becomes an inability to stay solvent.
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