What’s all the fuss about the Debt Limit?
Today is a special day - the U.S. government has hit its “debt ceiling”, a Congress-imposed limit on the amount of debt the government can legally borrow. Currently, it is at $14.294 trillion dollars. Yes, that’s with a ‘t’. So what does this mean? Does it mean the world is ending, as some have claimed? Or does it mean nothing at all, as others have said? The truth is it’s somewhere in between – but to which side it leans is the important part. To make an objective view, lets first get some history about the debt limit.
History and Purpose
In 1917, the U.S. Congress passed the Second Liberty Bond Act, a measure passed at the time to help finance U.S. expenses incurred while entering World War I. This allowed the Treasury to issue what were called “Liberty Bonds”, or long-term bonds that were paid back at low rates to help finance major expenses, therefore holding down interests costs. A similar raise occurred to help finance WWII efforts as well. It has been raised 74 times since March 1962, most of those times small increases to account for inflationary pressure. A few times have been large, however, such as in 2000-2007, when they were raised a total of over $4 trillion.
So if it’s raised almost every year, what’s the point of even having a debt limit in the first place? To be fair, the ceiling’s intentions are good – it’s supposed to help limit Congressional spending. Obviously this is not effective, however, and budget experts agree that the proper channel for such limitations is in forum debate and legislation, where details can be properly worked out and solutions made, rather than a hard cap. Furthermore, the party not holding majority power in government at the time nearly almost always votes against raising the debt limit; making a serious issue often a partisan one. (President Obama voted against raising the limit in 2006, but has since called that a mistake.)
What Happens if We Ignore it?
A big question is what happens if Congress just decides, “Forget it, we’ll just not raise the limit.”? Case in point – today. The government will not shut down; nor will it effectively go into default immediately. The U.S. Treasury has quite a few tricks up its sleeve that it can do to avoid defaulting on the debt, as well. Currently, the U.S. Treasury has delayed pension payments and suspend issuance of securities to state and local governments, and will probably move to cease offering a few of its other securities and investments. This will effectively give the Treasury around another 2 months or so, according to most estimates, but are only temporary measures.
Does this affect anything? Currently, no – bond rates have stayed low today, and one can assume from such that global investors and markets still view the U.S. as financially solvent. However, the closer we get to the limit, the more precarious this becomes.
The Final Countdown
According to most estimates, the Treasury will effectively run out of emergency measures on August 2nd, 2011. What would happen if that occurs without a raise in the debt ceiling? Well, Treasury Secretary Timothy Geithner put out a statement just today on that:
Interest rates for state and local government, corporate and consumer borrowing, including home mortgage interest, would all rise sharply. Equity prices and home values would decline, reducing retirement savings and hurting the economic security of all Americans, leading to reductions in spending and investment, which would cause job losses and business failures on a significant scale.
Default would have prolonged and far-reaching negative consequences on the safe-haven status of Treasuries and the dollar’s dominant role in the international financial system, causing further increases in interest rates and reducing the willingness of investors here and around the world to invest in the United States.
Many economic experts have also affirmed the statement that the dollar would drop significantly as a global stabilizer should default happen (see Greece for an example of such a default on a weak currency), which would drastically affect exchange rates on the dollar, as well as imports and exports.
But that’s not all, apparently; since the government would effectively run out of money (and by law because of the debt limit could not “print” more), military salaries and benefits, Social Security and Medicare benefits, Medicaid payments to states and all tax refunds would be halted immediately. Most discretionary programs (such as parks, grant programs, etc) would be halted, as well. U.S. Bonds would take a tailspin; Former Congressional Budget Director Rudolph Penner is quoted as saying “Our bond market and stock market would crash.” Treasury bond rates would likely rise 0.5%. J.P. Morgan estimates that GDP would drop 1%, and mortgage rates would rise 0.5%.
Of course, Congress would have until August 2nd to deal with this. Most experts think that Congress will not risk such severe repercussions and eventually pass a raise in the limit. Currently, House Republicans are opposing the limit (remember, they are the minority party, as stated earlier). House Majority Leader John Boehner has stated that he will not raise the ceiling without spending cuts (but will not agree to tax or revenue increases designed to cut the deficit). Democrats, with a few exceptions, being in the majority, have supported raising the limit.
Obviously, there is a lot of political games going on. Republicans are following polls that show most of the public oppose raising the limit (although, to be fair, most of the public is woefully uninformed in proper financial policy). So we’ll see what happens in the next couple of months. But, as shown, not raising the debt limit won’t immediately hurt us, but come August, will.