The biggest fiscal fight of the new year is lining up to be one over raising the federal debt limit. Here is what to expect as the showdown intensifies over the coming months.
What is the debt limit?
The U.S. debt limit is the total amount of money the government is allowed to borrow.
The debt ceiling was first created in 1918 and was originally set at $11.5 billion. Congress enacted the first aggregate debt limit that covered almost all government debt in 1939 and set it at $45 billion.
Congress is the sole body that has authority over raising the limit. Currently, the borrowing limit, also referred to as the debt ceiling, is $31.4 trillion. It was last increased to that level some two years ago.
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Of that $31.4 trillion, about $24.5 trillion is debt held by the public, and nearly $7 trillion is intragovernmental holdings, which are mostly debt held in trust funds, such as those for Social Security.
The federal debt as a percent of gross domestic product is a whopping 120%. Federal debt eclipsed 100% of GDP in 2014, although it was also above that level in the aftermath of World War II.
Lawmakers have raised the debt limit nearly 100 times since it was enacted in order to prevent the United States from defaulting, and Democrats are pushing for Congress to raise it once again this year. House Republicans, though, now in the majority, are hoping to exact concessions from President Joe Biden in exchange for voting to increase the ceiling.
How does the debt limit relate to a government shutdown?
The threat represented by the debt ceiling is not the same as the threat of a government shutdown — it’s much more serious. The two situations are often confused by those reading the news and even by some lawmakers.
A government shutdown can occur when Congress disagrees on funding future spending by government agencies. When the government shuts down, some workers are furloughed, and some government services go unprovided. In the 2018-2019 government shutdown, for example, some national parks fell into disrepair, and some craft beer makers couldn’t get labels for their products. Overall, the economic fallout was limited, as it was on the other occasions when the government shut down.
The debt ceiling, in contrast, allows the Treasury to take out debt to pay for spending already authorized in the past. Raising the debt ceiling does not authorize new spending. Instead, it allows the Treasury to make pay incoming bills — most significantly, the interest payments owed on the debt.
The U.S. has never failed to make an interest payment on the debt in modern times (apart from failing to pay some smaller investors on time in 1979 because of a glitch in the system for processing payments).
When will the debt limit be reached?
Last week Treasury Secretary Janet Yellen announced that the Treasury expects the debt limit to be reached on Thursday.
The debt subject to the limit stood at $31.3 trillion as of Friday, just short of the $31.4 trillion limit.
What happens when the limit is reached?
When the limit is reached, the Treasury may no longer issue new debt — that is, Treasury bills, notes, and bonds.
To pay the government’s incoming bills without issuing new debt, the Treasury will turn to what are called “extraordinary measures” to free up cash — essentially, shifting money around government accounts.
For example, the Treasury can prematurely redeem Treasury bonds held in the retirement savings accounts of federal employees, suspend state and local government series securities, and halt contributions to some government pension funds.
The measures have been used at least 16 times since first being deployed in 1985, according to the Committee for a Responsible Federal Budget, and as recently as 2021.
Still, the extraordinary measures will eventually run out. Yellen said they would be sufficient to carry the U.S. through early June, setting up a rough deadline for the congressional showdown.
At some point, the Treasury will no longer be able to guarantee that it can make all incoming payments on time and in full. That point is referred to, a bit ominously, as the “X-date.”
Bills come due to the Treasury in lumps. For example, the Treasury might have to pay a $4 billion bill for federal salaries one day and then a $30 billion bill for Medicare and a $40 billion bill for interest on the debt the next business day. On certain days, the Treasury might also get tax payments. But at some point, it may not have enough cash on hand to pay a bill in full.
At that point, in theory, the Treasury would have to decide to either make some payments in full and skip others or make payments as they come up and delay subsequent payments. Some of the choices would be tough, such as withholding Social Security checks from disabled recipients, and others would be unthinkable, such as defaulting on an interest payment on the debt. In any scenario, it is thought that the Treasury should prioritize interest payments on the debt, as Treasury securities underpin the global financial system.
Past Treasury secretaries of both parties have said there is no workable plan for prioritizing payments — that doing so would not be feasible.
Still, congressional Republicans have in the past drawn up legislation to prioritize certain payments if the debt ceiling isn’t lifted.
What would happen if the US defaulted on the debt?
It is thought that defaulting on the debt would have catastrophic effects on the economy. Casting doubt on payments on Treasury securities, viewed globally as a risk-free asset, could send interest rates soaring and have profound knock-on effects for nearly all financial instruments.
A default would have a similar effect on the economy as the Great Recession, which was the worst economic downturn since the Great Depression, according to a report by Moody’s Analytics. Moody’s predicted in 2021 that the fallout would be so severe that investors would panic and pull their money from the stock market, causing stocks to plunge by a massive 33%.
“Stock prices would be cut almost in one-third at the worst of the sell-off, wiping out $15 trillion in household wealth. Treasury yields, mortgage rates, and other consumer and corporate borrowing rates spike, at least until the debt limit is resolved and Treasury payments resume. Even then, rates never fall back to where they were previously,” said Mark Zandi, Moody’s chief economist.
During the closest brush with default, the 2011 debt limit crisis, the economy still experienced a blow despite the default never materializing. Stock prices fell in the lead-up to the eventual agreement to raise the ceiling, and it took half a year for them to recover fully, according to the New York Times. Additionally, credit rating agency Standards & Poor’s downgraded the U.S. economy from its AAA rating.
What are the two sides saying?
So far, Republicans have made it clear that they want to use the moment to work on reducing federal spending and debt.
McCarthy said on Sunday that he is willing to work with President Joe Biden and congressional Democrats on a deal to cap government spending and side-step a default, although details of exact numbers and demands are still not clear.
“I want to sit down with him now so there is no problem,” McCarthy said on Fox News. “I’m sure he knows there’s places that we can change that put America on a trajectory that we save these entitlements instead of putting it into bankruptcy the way they have been spending.”
“I believe we can sit down with anybody who wants to work together. I believe this president could be that person,” he said.
House Minority Leader Hakeem Jeffries (D-NY) has accused Republicans of putting the country in a dangerous position over the debt limit showdown. In a recent interview with NY1, he warned of global economic fallout.
“In our country’s history, which is about 247 years old, the United States of America has never defaulted on our debt. And if we were to do so, because of extremist Republicans in the House, that will have grave consequences for Social Security, for Medicare, for the economy and the, in fact, not just for the country but for the world,” Jeffries said.
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Meanwhile, Yellen also emphasized just how high the stakes are if the government continues to head toward a default. In her letter last week, she noted how even the perception that the U.S. might default would hurt the economy.
“Failure to meet the government’s obligations would cause irreparable harm to the U.S. economy, the livelihoods of all Americans, and global financial stability,” Yellen said.
