Perhaps Americans have grappled with too many apocalyptic economic scenarios this year to care about understanding the debt ceiling. But this one was really bad. The government workers still getting paid and reporting to work – specifically, Congress – managed to put the United States’ credibility and the stability of the global economy at risk with the latest crisis, which is likely to be circumvented Wednesday night.
What is the actual ceiling and what does it limit?
The government is only authorized to borrow a limited amount of money to pay for legal obligations. Those obligations include payments for programs the government has already authorized, such as Social Security, interest on the federal debt and Medicare payments.
The ceiling is the total amount the government can borrow. That ceiling was $16.7 trillion dollars, a point we reached back in May. Our Treasury Department has used “extraordinary measures” to continue borrowing since then, which include holding interest rates and redeeming or suspending certain government funds.
So, what would have happened on October 17th?
The Treasury said – in what may be the perfect example of a strongly worded letter – that those extraordinary measures will run out, meaning Congress needed to raise the debt ceiling, or we will have run out of options for borrowing money. At that point, if at any point more debts come due than we have the revenue on hand to pay for, we will be in default.
Is the debt the same as the deficit? Will our debt be affected by changing the debt ceiling?
According to economist Paul Krugman, nobody understands debt, anyway. Each year, the government runs a deficit or a surplus. The difference between the amount the government collects each year and what it spends creates the deficit. When we combine all of the deficits or surpluses, we get the debt.
Raising the debt ceiling will allow the U.S. to actually pay for things it already agreed to pay for and will not add to the list of obligations. Deciding to limit spending cannot solve the debt ceiling problem because the spending obligations have already been decided. However, some politicians wanted to tie negotiations about the debt ceiling to cutting spending, or reducing the deficit.
How is the debt ceiling related to defaulting on the debt?
An inability to pay for scheduled principal or interest payments on the debt would result in a default.
Some experts say, however, the government could service its debt and prioritize such payments to avoid default. Treasury Secretary Jack Lew has insisted that this is not possible.
If the U.S. – the largest borrower in the world – actually defaults on its debt, a global financial catastrophe would have ensued, even worse than the collapse of Lehman Brothers in 2008. The amount of outstanding U.S. government debt is 23 times what Lehman owned when it filed for bankruptcy.
How can it get worse than a government shutdown?
The shutdown occurred at the end of the U.S. Fiscal Year on October 1st because Congress could not reach a deal on a spending bill, resulting in a partial shutdown of government agencies and services categorized as “non-excepted.” Around 800,000 government workers have been furloughed.
In this state of partial government shutdown, workers have suffered along with our international image and citizen’s confidence in our lawmakers.
If we become unable to finance our existing obligations to people relying on government programs and creditors, we will experience even more severe damage to global confidence in the U.S. As insane as it sounds, the government has shut down before - several times before, in fact. We have never defaulted on our legal obligations.
Faith in the U.S. dollar is precisely what maintains our status as the preeminent global reserve currency. Loss of faith in the U.S. government, economy and Treasury caused by the debt ceiling negotiations and possibility of default can thus be quantified in the form of credit downgrades, reduced investor confidence and disruption to financial markets.
For example, J.P. Morgan has already sold most of its short-term treasuries because of the current crisis. When investors sell bonds because of a negative economic outlook, interest rates increase, which ultimately reduces borrowing and slows the economy.
Would the global economy have been affected?
Yes. Breaking the world’s trust in the United States will have very real consequences — the global financial system is essentially predicated on the norm that the U.S. government meets payments on its debt. A default could “devastate stock markets from Brazil to Zurich, halt a $5 trillion lending mechanism for investors who rely on Treasuries, blow up borrowing costs for billions of people and companies, ravage the dollar and throw the U.S. and world economies into a recession that probably would become a depression.”
The impact of a default would not be limited to financial markets. World Bank President Jim Yong Kim said the increase in interest rates, lowered confidence and slowed growth associated with a borrowing crisis would devastate the world economy, hitting the poor particularly hard.
What would have happened if we didn't raise the debt ceiling but managed to avoid defaulting on debt payments?
A failure to raise the debt ceiling would also affect important government payments to its citizens, like Social Security or payments to government contractors. Huge, sudden cuts in government spending not only affect those relying on payments, but also the economy on a macroeconomic scale.
Prioritizing payments on the debt would reduce government spending by $175 billion during November alone, said a Goldman Sachs economist. During times of economic downturn, government spending has a larger effect on the economy because of how it changes the multiplier.
How did we get to this point?
Congressional stalemate. You may have heard about it, but Congress hasn’t exactly been a paradigm of negotiation recently, and the American people are mad. Debate about raising the debt ceiling has become intertwined with arguments about the heavily partisan issue of government spending and doubts about the consequences after October 17th. While Congress has historically argued about raising the debt limit, this debate has grown to include demands for certain political terms. Representative Peter Welch, a Vermont Democrat, described the issue as “a nuclear-tipped leverage point.”
Luckily, Congressional action seems to have prevented the borrowing crisis and only seriously damage their credibility and call into question the stability of the U.S. financial system, again.