The discussions on the US debt ceiling regularly plague the USA, often sidestepping the underlying problem and opting for temporary solutions over decisive action. The debt ceiling, enacted through the Second Liberty Bond Act of 1917, is the maximum amount the United States can borrow to fulfill its legal obligations, including Social Security, Medicare, military salaries, national debt interest, tax refunds, and other payments.
The purpose of installing a debt ceiling is to ensure fiscal responsibility and prioritize spending. Over the past 64 years, the United States has already raised its debt limit 78 times. Since 2001, the US government has consistently incurred a trade deficit, averaging nearly $1 trillion annually. The national debt currently exceeds $34.5 trillion, surpassing the GDP of $24.78 trillion.
Over the years, the debt ceiling, once a fiscal safeguard, has morphed into a political weapon. In August 2011, Americans witnessed the looming crisis of default, triggering a 20% drop in the intraday stock market. The political party in power at the time of a potential default would bear the brunt of the losses, prompting parties to revise the debt limit to avert global economic turmoil.
Why does the US keep raising its debt ceiling?
According to the Biden administration, raising the debt limit is a non-negotiable obligation to avert economic chaos. Raising the debt ceiling enables the US to continue funding federal operations, empowering its leaders to sustain government activities. Failing to raise the debt limit would result in the US government defaulting on its bills, leading to disastrous consequences such as massive layoffs, a crash in US stock markets, and an economic recession.
The US has accumulated debt over the years, but significant growth began in the 1980s with President Ronald Reagan’s introduction of massive tax cuts, leading to increased government borrowings. The 2000s saw further increases due to events like the Dot Com Bubble Burst, tax cuts in 2001 and 2003, expenditure on US military operations in Iraq and Afghanistan, and the 2008 Financial Crisis. The 2017 tax cuts, the COVID-19 pandemic, and the Russia-Ukraine war exacerbated the debt-ceiling crisis. Moreover, the operation of federal programs in autopilot mode, which do not require annual approval and account for 63% of the total budget, necessitates yearly government funding, contributing to the debt.
Economic Fallout of the US Debt Ceiling Stalemates
The debt ceiling aims to prevent the government from overspending; however, critics suggest that it could produce economic uncertainty, undermining the nation’s credit ratings. Such a downgrade would potentially lead to higher interest rates on government debt, making it more expensive to borrow while adversely impacting investor confidence. In 2011, credit agencies demoted the US from its AAA to AA+ credit rating while Congress debated suspending the debt ceiling.
A US default would restrict the Treasury Department from issuing any bonds, bills, or notes, forcing the government to rely solely on tax revenue. If the tax revenue is insufficient, the Treasury Secretary would face difficult decisions, such as choosing between paying salaries to federal employees, interest on national debt, or social security benefits. Economists at Moody’s estimate that 7.8 million American jobs would dissipate, borrowing rates would soar, and unemployment rates would hike from 3.4% to 8%, with the stock market plummeting and erasing $10 trillion in household wealth.
Moreover, the dollar could potentially lose its dominance as the international unit of account, compelling the US to pay its debt in foreign currency and enhancing the position of rivals like China. A default would subject the US to exchange rate risks and result in a loss of political power. Investors would charge higher interest rates if they perceived US debt as a long-term risk, causing a cascade of higher rates across the economy, including credit card rates, mortgage rates, car loan rates, and general borrowing rates. Millions dependent on the government would suffer, with a default sparking a recession and hurting retirees the most.
Exploring Solutions and Global Practices
Several countries, including Australia, Denmark, and Poland, have implemented debt ceilings to regulate their finances. However, the evolution of the debt ceiling in the United States has created a unique economic and political dilemma. The closest resemblance to the US debt ceiling is Denmark’s. Denmark’s politicians often align their ideas to manage finances sustainably, unlike the US Congress. Denmark has notably reduced its debt and achieved a budget surplus. The Fed must explore avenues to reduce the US debt and boost revenue beyond taxation. The Federal Reserve should enact stricter borrowing regulations and reevaluate annual budgeting processes to accommodate savings.
Moreover, the US could establish a debt containment and expense-control mechanism that is directly sensitive to cyclical changes in the economy, kicking in when employment is low and deficits are high. The ‘Debt Brake’ model, introduced by the Swiss government in 2001, suggests that during economic booms, the government must use its surplus revenue to pay off bills, while allowing for extraordinary expenses in case of any economic crisis or unforeseen events such as wars and pandemics. Although approval for such expenses by Parliament would be required, this model ensures timely payment of debt, avoiding long-term imbalances.
