The Danger (and Drama) of the Debt Ceiling

You can’t turn on the TV or check your smartphone without seeing someone talk about the looming federal debt ceiling and the ability of the Treasury Department to pay our country's debts.

It’s not a new problem; over the years, policymakers have repeatedly sought to raise or eliminate this debt limit to avoid government shutdowns.

What Is the Debt Ceiling?

The debt ceiling is the amount of money the U.S. government can borrow to meet its existing obligations. This isn’t new spending, only what Congress already authorized when it passed the federal budget.

The official debt ceiling stands at $31.4 trillion—and we technically hit that limit back in January. Since then, the Treasury Department has been using so-called “extraordinary measures” to keep the government funded and running.

But those accounting and budgetary tricks are expected to run out in June. This means that Congress will have to raise the borrowing limit before then or else default on the nation’s debt.

History (and Politics) of the Debt Ceiling

The debt limit as we know it today dates back to the Great Depression. Back then, Congress thought it was doing itself a favor by creating one single debt ceiling, as opposed to having to vote to authorize each and every new Treasury bond issuance. And, for the record, the debt limit has been raised time and time again since then under both Republican and Democratic presidents.

It’s only in recent decades that the debt ceiling has become a political tool to attempt to wring concessions from the party in the White House. In our view, the tax and spending decisions of prior decades and administrations all contribute to the current situation—no party legitimately can take the fiscally responsible high ground here.

Today’s Debt Crisis…and Looming Recession

The absolute debt level and the debt-to-gross domestic product (GDP) ratio are at or near all-time highs. This level of debt is undesirable because not only would it crowd out other federal spending, but also the need to finance an ever-larger debt means more borrowing.

This creates a negative feedback loop as higher rates raise funding costs—and more borrowing increases Treasury bond supply, which raises interest rates.

In addition to the debt ceiling clash, we may well be headed for a recession. If that’s true, then we may need fiscal policy support later this year, or roughly around the time we actually reach the debt ceiling.

On top of these considerations, the reality is that our politics are highly polarized, meaning this debt ceiling dogfight may be more brutal than previous episodes.

Will Congress Act?

Even with all the political posturing and theatrics, I refuse to believe either political party will permit the government to default on its debt. The ramifications of such a default could be devastating for not only the U.S. financial system but indeed the world global financial order. But that doesn’t mean it’s smooth sailing ahead—markets could be very volatile as we near the deadline, with no apparent solution.

The U.S. dollar is in effect the global currency. And U.S. Treasury debt, backed by the full faith and credit of the U.S. government, is perceived as a safe-haven investment around the world for its potential to retain its value amid market turbulence. It would be unprecedented and represent a self-inflicted wound of historical proportions to upend that system.