Debt Ceiling Explanation
August 1st, 2011 at 12:37 pm | Type:
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With all of this news and political talk about the “debt crisis” flooding the internet and television, I thought I’d give a brief explanation of the whole situation. There is obviously a lot more that can be covered in a discussion, but this scratches the surface and will hopefully educate anyone confused on the situation.
Article courtesy of Kalen Smith and Money Crashers
Debt Ceiling Explanation
It’s a simple truth: Every year the United States Gov’t spends more money than it brings in revenue. To fund many national programs, the government borrows money by issuing Treasuries. In a given year, 40 to 50% of U.S. expenditures are made with borrowed money.
As we continue to borrow money without paying back the debt, the federal deficit continues to increase. To keep government debt from getting “out of control,” Congress has limited spending through a national debt ceiling. As our deficit has reached this alarming maximum, the debate rages: Should we increase the debt ceiling or change our spending policies?
Debt Ceiling Defined
Simply put, the debt ceiling is a cap on the amount of money that the U.S. government is allowed to owe. It includes both public and private debt.
Since 1917, Congress has agreed on a limit of how much debt the U.S. can owe without risking default, and legislators raise the limit when they feel we need to borrow more money to sustain the economy. The legislature has raised the debt ceiling 74 times in the past 50 years, and about ten times since 2001. At this point, some voters and leaders feel that it doesn’t even make sense to have a debt ceiling, since Congress has the option to raise it virtually any time.
Currently, we have reached the $14.3 million debt ceiling. There is now intense debate as to whether this ceiling should be raised, and what kind of expenditure cuts must be made by the government to reduce this deficit over the long term.
Arguments for Raising the Debt Ceiling
Many economists are mortified by the debt we’re facing, but still advocate for raising the ceiling. They feel that if we don’t raise the limit, the nation could face an economic catastrophe. Potential consequences that Congress will consider are:
- Cuts to nonessential programs. Programs like the National Parks Service would be shut down because Congress wouldn’t have the money to pay them.
- Government shutdown and sending home federal employees. Washington would have to place nonessential government employees on leave, sending millions of federal workers home until the debt situation is resolved.
- Default on existing debt. The government starts out in deficit before it can even pay interest on current Treasuries or pay for the bonds as they reach maturity. That means that the U.S. has to borrow more money just to pay off existing debts, and without raising the ceiling, the government would default on most of its existing debt obligations. Some people have gone so far as to describe the U.S. economy as a giant Ponzi scheme, and if the instability were exposed, citizens and other governments would quickly lose faith in the U.S. government. China and many other nations holding our debt are already afraid that we’re about to default. Lack of trust would make lenders less likely to provide funds in the future, seriously damaging our trading position with the rest of the world. Interest rates would skyrocket if the nation’s credit rating dropped.
- Economic repercussions. If the government’s cash flow got cut off, then Congress would have to either double taxes or slash the budget by more than half. Either choice would have a devastating effect on the economy, undoing the recent recovery efforts. In addition to rising interest rates, we’d face a damaged stock market and higher unemployment, sending a shock wave of economic turmoil through the rest of the world.
Cautions about Raising the Debt Ceiling
These ramifications are so serious and certain that it is almost certain that Congress will raise the debt ceiling again. Doing so seems essential to the survival of our country, but this short-term fix comes with long-term potential problems. Experts who are apprehensive about raising the ceiling have a variety of valid reasons, including:
- Responsibility. Yet another increase in the debt ceiling will just tempt our government to continue borrowing money and spending beyond its means. It’s like a credit card company raising your limit when you’ve maxed out and consistently missed payments. The government will lose sight of the immediate and long-term problems that we are facing and continue to fail to address the deficit.
- Collapsing dollar. Raising the debt ceiling devalues the dollar. Our currency becomes riskier and less stable as we become more likely to default on our existing debts. This declining value weakens our purchasing power and could cause the dollar to lose its position as the world reserve currency. Inflation has already increased substantially and the rising price of food and oil are starting to get out of control.
- Futility. The U.S. is already having more trouble than ever finding investors to borrow our debt. Last year, the Federal Reserve only had to purchase 10% of available U.S. treasuries. Today, they are purchasing close to 70%. As interest rates have dropped to record lows (about a .25% for a one-year bill), investors don’t see any point in investing in them. With countries like China unloading their current holdings in U.S. treasuries, we’re starting to lose our market for foreign investors. With the country risking default, Standard and Poor’s has already threatened to lower our AAA bond rating. If S&P drops the rating and major companies won’t buy our debt, it may simply be too late for an increase in the debt ceiling to solve the problem.
- Sending a message. Deciding not to raise the debt ceiling could signal to international community that we’re serious about controlling our situation. Providing that sign just might be the best move we could make. The rest of the world is looking for assurances that we are going to work at getting our spending under control. Rather making than another last-ditch effort that might not work, if Congress maintains the current debt ceiling and focuses on making drastic cuts and structuring a healthier economy, we’d be giving the world, especially major nations that hold our debt, the message that they want to hear.
What Will Happen to the Debt Ceiling?
In the end, Congress almost certainly feels as though it has no choice but to raise the debt ceiling. Along partisan lines, it seems that the Republican majority in the House has come to accept this opinion, but members are threatening to not cooperate unless the Democratic Party listens to its demands for changing the fiscal budget.
Ultimately, the two sides need to come together on a compromise and decide which programs they need to cut and whether taxes should be increased. Without an amicable, effective resolution, Congress may have to withhold payments to federal employees and programs, and the government may temporarily shut down. Moreover, the US is at risk of a credit downgrade, which could send ripples throughout the world economy and lead to an intense recession.
Final Word
Clearly, Washington needs to settle the debt ceiling debate very soon. Though this isn’t the first time that the topic has come up or sparked heated discussion, this is the most alarming situation we’ve faced.
As our country continues to get itself deeper into debt, we have to come to the conclusion that we are going to have to start changing the way we manage our economy. We cannot forever depend on short-term solutions that get us into deeper debt. Sooner or later, we will have to accept that we are going to have to change taxes, reduce spending, and start resolving our debt situation before we continue to borrow more money. This next debate may be a turning point for our country and we will see where it takes us.
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