What is the Debt Ceiling, Why Does it Matter, and What Would Happen if America Defaults?

The debt ceiling is a term that refers to the amount of money the United States government is allowed to borrow to meet its current obligations. Since the U.S. government currently spends more than it brings in, these obligations include spending for all of the services the government provides to its citizens as well as the interest on the national debt. So in simple terms, the United States needs to borrow more money to pay off the money it borrowed.

How Did We Get Here?

Looking for a way to pay for World War One, without having to resort to annual budgeting, in 1917, Congress authorized more flexibility to the Treasury Department and began limiting how much money it could borrow. This became known as the “Debt Ceiling” or the most borrowing allowed.

Since 1960, the debt ceiling has been raised a total of 78 times. The Republicans have raised this limit 49 times and Democrats have raised it 29 times in the preceding years. Since the government constantly needs more money to pay for the money it has previously borrowed it requires permission from Congress to raise the amount of money it’s allowed to borrow.

How Would a Default Matter?

To put this question in simplistic terms, what would happen if you just didn’t have the money available to pay your monthly car payment or mortgage? The outcome of not being able to pay your monthly loans would be dire. Not only would the items you borrow money to purchase be repossessed and foreclosed on (an official way of saying “taken back”), your credit rating would crash and you wouldn’t be able to borrow more money in the near future.

The same outcome is essentially true with the United States. If Congress doesn’t increase the amount of money the government is allowed to borrow to pay its bills, the country would default on its obligations for the first time in history. This default would be catastrophic to the economy of, not only the United States but, the world.

If the U.S. Defaults, What Would be the Likely Outcome?

It isn’t an exaggeration to say a default by the United States on its debt would be a catastrophe. Unlike other countries around the world, the United States has always been expected to be able to pay its debt. As with any other loan, the interest rates charged on a loan are based on the risk involved in receiving payments on the loan.

The United States has always been considered “risk-free”. This means the U.S. pays less interest to borrow money. This risk-free rating and trust have also made the U.S. dollar the global reserve currency, which gives the United States economic and national security. This very security is constantly trying to be undermined by competing countries.

A default by the United States would mean it can no longer be trusted to pay its debt, which would create several other problems for the country. Interest rates would increase for the government as well as its citizens. The dollar would be weakened globally and remain that way for a very long time, if not forever. Most analysts are convinced a recession, with negative long-term effects, would immediately follow a default by the United States.

Warning to Congress

In mid-January of this year, Treasury Secretary Janet Yellen restated how important it was for Congress to raise the debt ceiling to avoid a default by the United States.

“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,” she wrote. “I respectfully urge Congress to act promptly to protect the full faith and credit of the United States.”

House Speaker Kevin McCarthy’s Effect on the Debt Ceiling

The election of California Republican Kevin McCarthy to the Speaker of the House Position is believed by some economists and Wall Street analysts, raising the likelihood that lawmakers will vote against raising the debt ceiling by the “hard deadline” of June 1st that Treasury Secretary Yellen has established.

Republicans have indicated, as part of their support to elect McCarthy, they will vote against raising the debt ceiling without significant reductions in spending. This has set the stage for the political gridlock we are experiencing now.

Not Our First Rodeo

There have been several debt ceiling showdowns in the past, some of which have even led to government shutdowns. One of the most notable showdowns happened in 1995 when Republicans, led by House Speaker Newt Gingrich, threatened to refuse to raise the debt ceiling unless there were government spending cuts.

President Clinton refused to make the cuts and this led to a government shutdown. Eventually, the President and Congress came to an agreement for a balanced budget that included modest spending cuts and tax increases. A similar stand-off happened during the Obama administration in 2011. During that time, the U.S. Treasury debt lost the triple-A rating it had held for more than 70 years. 

A notable instance in August 2019, President Donald Trump signed the Bipartisan Budget Act of 2019, which suspended the debt ceiling through July 31, 2021. This legislation also raised spending caps on federal agency budgets and ensured the government would be able to pay its bills during this period. This action eliminated the risk of default for another two years.

Default is Unlikely

Despite all of the political rhetoric and posturing it is unlikely the debt ceiling won’t be raised, forcing the United States to default on its debt. Honestly, the consequences of a default are too catastrophic for either party to force a default. Unlikely but, of course, not guaranteed. If the deep division in our country recently has taught us anything it is that nothing is guaranteed.

In Conclusion

Even though it is unlikely the United States will default on its debt and plunge the global economy into turmoil, nothing is guaranteed, especially in the current political context. If the United States ever defaulted on its debt the repercussions, not only in this country but globally would be significant and long-lasting. You only need to look at the housing crisis of 2008 to prove that, however, a default would create a situation significantly worse.

Taking all of this into consideration you have to ask yourself how much longer can we continue with such a significant debt? Are we only prolonging an inevitable default?