Table of Contents
- What is the Debt Ceiling?
- Why it is important to address the Debt Ceiling in time and How this affects you
- Historical Consequences of Debt Ceiling Standoffs
- Possible Solutions
- What you should do
As of January 2023, the total national debt and the debt ceiling both stood at $31.4 trillion. But, what is the debt ceiling? Why should it be raised? And how does it affect you?
What is the debt ceiling?
The debt ceiling, also known as the debt limit, is a legislative limit on the amount of national debt that can be incurred by the U.S. Treasury. When the Treasury Department spends the maximum amount authorized under the ceiling, Congress must vote to suspend or raise the limit on borrowing.
The debt limit does not authorize new spending commitments. It simply allows the government to finance existing legal obligations that Congresses and presidents of both parties have made in the past. It sets a maximum cap on the total outstanding debt that the government can have at any given time. Once the debt reaches this limit, the government is not allowed to borrow any further funds unless the debt ceiling is raised or suspended.
The concept is similar to how a credit card limit would work. The debt ceiling for the country is the maximum debt that the US is allowed to accrue.
Why is it important to address the debt ceiling in time?
In the event that the debt ceiling is not raised or addressed in a timely manner, the government may face a potential default on its debt obligations.
However, it’s important to note that the debt ceiling does not directly control or influence the government’s spending or revenue. It primarily functions as a constraint on borrowing to finance the existing obligations and commitments already approved by Congress.
The Treasury Secretary as of May 2023, Janet Yellen, initially mentioned that the date by which the debt ceiling needs to be addressed in 2023 is June 1st, although she later said that the Treasury was able to move that date to June 5th by moving some funds around.
If the debt ceiling is not raised by this date, it could have serious consequences for the economy and financial markets. Here is some of the fallout that could occur if the debt ceiling is not addressed in time.
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- Potential Government Default: The most immediate and severe consequence of not raising the debt ceiling is the risk of a government default on its financial obligations. If the government reaches the debt ceiling and is unable to borrow more funds, it may not have enough cash on hand to meet all its payment obligations, such as paying federal employees, making Social Security payments, or honoring interest payments on Treasury bonds. Here are some payments due in the next week, which will not be made unless the debt ceiling is raised or suspended
June 1st, 2023:
| Pay To | Amount Due |
|---|---|
| Medicare | $47B |
| Veteran Benefits | $12B |
| Military Pay and Retirement | $10B |
| Civil Service Retirement | $6B |
June 2nd, 2023:
| Pay To | Amount Due |
|---|---|
| Social Security | $25B |
Thousands of people in the government or who expect a social security payment will not be paid next week if the debt ceiling is not addressed!
- Credit Rating Downgrade: Failure to raise the debt ceiling could lead credit rating agencies to downgrade the United States’ credit rating. A downgrade would make it more expensive for the government to borrow money in the future, increasing interest costs and potentially negatively impacting consumer and business borrowing rates as well. Credit card and mortgage interest rates are expected to rise as a result of a credit rating downgrade.
- Economic Contraction: A default or prolonged uncertainty around the debt ceiling could significantly impact the broader economy. It could lead to a contraction in economic activity, reduced business investment, and increased market volatility. Consumer confidence may decline, leading to decreased consumer spending and slower economic growth.
- Damage to International Reputation: Not raising the debt ceiling could harm the perception of the United States’ ability to manage its financial affairs. It may erode trust in the U.S. government’s ability to honor its obligations and maintain its position as a global economic leader. This could weaken the U.S. dollar’s status as a reserve currency and have long-term implications for international trade and financial relationships.
- Disruptions in Government Operations: In the event of a government default or prolonged uncertainty surrounding the debt ceiling, there may be disruptions in government operations. This can include delays or interruptions in essential services, government programs, and payments to contractors and suppliers. Government shutdowns, like those experienced in the past, can have a wide range of negative impacts on individuals, businesses, and the overall economy.
- Investor Uncertainty and Market Volatility: A failure to raise the debt ceiling can create uncertainty among investors and financial markets. Uncertainty regarding the government’s ability to meet its financial obligations can lead to increased market volatility, reduced investment, and a decline in overall market confidence.
Historical Consequences of Debt Ceiling standoffs
The United States has had a debt ceiling since 1917. Congress has raised the debt ceiling 108 times since 1960. In recent years, debt ceiling standoffs have become more common. This is because the debt ceiling has become a political tool, with both parties using it as leverage in negotiations over other issues.
The most recent instance of the debt ceiling not being raised was in 2011. The government shutdown that resulted from this impasse lasted for 16 days and resulted in the furlough of over 800,000 federal employees. The shutdown also had a significant impact on the economy, as it reduced economic activity by an estimated $24 billion.
The United States’ long-term credit rating was downgraded by one of the major credit rating agencies, Standard & Poor’s (S&P), on August 5, 2011. At that time, S&P downgraded the U.S. credit rating from AAA (the highest rating) to AA+. This downgrade came as a result of prolonged and contentious negotiations over raising the debt ceiling and concerns about the country’s fiscal situation. It marked the first time in history that the United States had its long-term credit rating downgraded.
The downgrade of the United States’ long-term credit rating in 2011 had several notable consequences:
- Market Volatility: The downgrade contributed to increased market volatility and uncertainty. Financial markets experienced significant fluctuations as investors reacted to the news and assessed the potential impacts of the downgrade. The market dropped around 14% in 4 weeks, and almost 20% in about 6 months due to the uncertainty around the debt limit
- Increased Borrowing Costs: The downgrade led to higher borrowing costs for the U.S. government. As the credit rating reflects the perceived risk of default, the downgrade resulted in higher interest rates on U.S. Treasury bonds. This increased the government’s borrowing costs and added to the overall cost of servicing the national debt.
- Weakened Investor Confidence: The downgrade had a negative impact on investor confidence in the U.S. government’s ability to manage its finances. It raised concerns about the country’s fiscal sustainability and the political willingness to address long-term debt and deficit issues. This erosion of confidence could potentially have long-term consequences for investor behavior and market perceptions.
- Global Impact: The downgrade of the United States’ credit rating had implications beyond its borders. As the U.S. dollar is a global reserve currency and the U.S. Treasury bonds are considered safe-haven assets, the downgrade had an impact on global financial markets. It affected investor perceptions of global economic stability and influenced other countries’ views on the United States’ fiscal health.
Possible Solutions
- Raising the debt ceiling: This is the most obvious solution, and it is the one that has been used most often in the past. However, it is also the most politically difficult, as it requires both parties in Congress to agree.
- Bipartisan Negotiations: Encouraging bipartisan negotiations and compromise can help find a resolution to the debt ceiling stand-off. By bringing together lawmakers from different parties, it is possible to explore common ground and develop a mutually agreeable plan to raise the debt ceiling while addressing concerns about fiscal responsibility.
- Abolishing the debt ceiling: This would eliminate the need for Congress to vote on raising the debt ceiling, and it would make it more difficult for the government to default on its debt. However, it would also give the government more power to borrow money, which could lead to higher deficits in the future.
- Passing a law that would automatically raise the debt ceiling: This would take the decision of whether or not to raise the debt ceiling out of the hands of Congress and make it more predictable. This could help to reduce uncertainty in the markets and make it less likely that the government would default on its debt.
What should you do in the meantime?
Considering that the politicians are aware of the repercussions to follow from a default, the possibilities of a default are slim. The expectation is that both parties will come together to get an agreement on dealing with the debt ceiling in time. That said, there is the small chance that things go wrong, and we go past the deadline. In the event of a default, here are things you need to consider
- Emergency Fund: Make sure you have a financial cushion. If you have some money to fall back on, you will be less likely to be affected by a government shutdown or a default on debt. This means having enough money saved up to cover your expenses for a few weeks to months, depending on how soon the standoff will last. This would be one of those times to tap into your emergency funds or rainy day funds to see you through what might be a financially straining time, especially if you are dependent on government money.
- Brace yourself for a bumpy stock market ride: Historically, the markets have reacted with volatility when faced with uncertainty. Buckle down as markets are expected to fall in times such as defaults. Don’t react in emotion and stay the course
- Expect variances if variable rate loans: If rates fall due to a credit rating fall it may affect your mortgage, credit card, or other variable rates. Budget accordingly for your monthly expenses.
- Plan for possible furloughs in government services: If you are a government employee, there is a higher chance of furloughs during a debt ceiling standoff as seen in 2011.
- Speak to your local representative: Speak to your local representative and stress on how important it is for both parties to get together to address the debt ceiling for the rest of the country.
In summary, hopefully the politicians in charge will do what is right for the country and ensure that we don’t default on our payments. In the meantime, do as much as you can to buffer yourself and your family from the negative effects on what might be a difficult period in the off chance the government doesn’t address the limit.
