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How The 'Debt Ceiling' Works

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How The 'Debt Ceiling' Works
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Making ends meet has become increasingly tough for the United States, and as expenses burgeon, the government has no other recourse but to bank on borrowings to keep the show going. This brings up the question of whether the United States can keep on borrowing to meet the ever-widening budgetary shortfall.

The answer is a simple "no."

What Is A Debt Ceiling?

There is a constraining factor called debt limit or debt ceiling that comes into play. The U.S. Treasury defines the debt limit as the amount of money the U.S. government is authorized to borrow to meet its existing legal obligations.

History Of The Debt Limit

The debt ceiling limit was first fixed by the U.S. government through the legislation of the Second Liberty Bond Act of 1917, with separate ceilings set for each instrument. The initial ceiling was fixed at $11.5 billion. A 1938 law set the first limit on the accumulated debt over all kinds of instruments at $45 billion, 10 percent above the total debt at that time.

In the 1980s the debt ceiling was raised to about $3 trillion from less than $1 trillion. This was subsequently doubled to $12 trillion in the 2000s. Following the Budget Control Act of 2011, the debt ceiling was automatically raised by $900 billion. It also vested the president with powers to raise the limit by an additional $2.1 trillion to $16.39 trillion.

Between February 2013 and March 2015, Congress suspended the debt limit three times, and in March 2015, the limit was set at the current $18.15 trillion. Suspension of the debt limit would mean that a ceiling is not in place for controlling the borrowing. Once the suspension period expires, the earlier ceiling would become applicable.

Consequences Of Debt Ceiling Violation

Once the debt ceiling is hit, some possible outcomes include:

  • The government goes through a shutdown, when it temporarily stops making social security payments, federal civilian employees' salaries, veteran's benefits, utility bills, etc. It closes down National malls and National parks.
  • Once the crisis precipitates to the stage of a default, when the government defaults on the debt obligations already due, it has far-reaching economic implications as well. Interest rates would rise and demand for U.S. Treasury securities would dwindle, as these would no longer be considered as safer bets. Cost of borrowing would escalate.
  • This in turn has the potential to destabilize the global economy as well, as lock stepping with higher U.S. Treasury rates, interest rates across the global would rise, affecting a host of interest rates that matters for consumers, including auto and credit card loans and mortgage payments as well.

What Is The Recourse When Violations Happen?

The government can temporarily extend, permanently raise or revise the definition of the debt ceiling if there is an impending risk of a debt ceiling violation. In the past, Congress had acted 78 times in separate instances to tackle a crisis on this front, 49 times under Republican presidents and 29 times under Democratic presidents.

Govt Debt Vs. Debt Ceiling

debt-limit-history-data-for-web-2013-updated-rjr-chart1_large.jpg Source:-Mercatus.org

Treasury On High Alert

With the federal debt poised to hit the debt ceiling limit, U.S. Treasury Secretary Steven Mnuchin wrote a letter to House Speaker Paul Ryan on March 8, apprising him of the extraordinary measures the Treasury anticipates to take to prevent a default. In the letter, Mnuchin said the Treasury would stop selling State and Local Government securities, beginning March 15.

Extraordinary measures are policy maneuverings to delay the need to raise the debt ceilings. These measures could include:

  • Premature redeeming of Treasury bonds held in federal employee retirement accounts.
  • Halting of contributions to certain government pension funds.
  • Suspending state and local government series securities.
  • Borrowing from money set aside to manage exchange rate fluctuations.

The clock is ticking. The debt ceiling suspension, which Congress adopted through the Bipartisan Budget Act signed into a law by former President Barack Obama on November 2, 2015, was supposed to run through March 15, 2017. Prior to that, the debt was suspended at $18.11 trillion for 235 days from March 13, 2015, until November 2, 2015.

To tide over the current crisis, the government has few options. It can either convince Congress to raise the debt ceiling or extend the current suspension. Alternatively, the Treasury could pass some makeshift extraordinary measures to give scope for lawmakers to reach an agreement on it. Regardless, the Trump administration has a tall order before it to cushion the economy from a potential default.

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Image Credit: By Office of the President of the United States (@realDonaldTrump on Twitter) [Public domain], via Wikimedia Commons

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