Here we go again. Every few years, it seems like Congress and the President play a game of chicken over the US Treasury’s debt ceiling. Just in time, the legislator succeeds every time in avoiding exceeding the limit value.
But there’s reason to worry that won’t be the case this time. And that would be an economic catastrophe.
The debt limit, also known as the debt ceiling, is the maximum amount of debt that the Treasury can issue. Given that the federal government is running large budget deficits — it spends more than it collects in taxes and other revenues — if the Treasury can’t borrow more, the government won’t be able to pay all of its bills on time . The limit is set by law and has been raised or suspended many times for over a century to allow the Treasury to fund government operations.
The intention of the debt limit was to force lawmakers into fiscal discipline — to spend less, tax more, and curb budget deficits and debt. It has failed miserably and instead threatens to wipe out the nation’s finances and economy.
Given the uncertainty surrounding the timing of government payments and receipts, it’s not possible to know exactly when the Treasury will run out of money to pay everyone on time. When it comes to that, the nation defaults. Treasury Secretary Janet Yellen says it could be as early as June. Moody’s Analytics best estimate is August, but no later than early October.
There is much debate over whether the Treasury Department could prioritize payments to government bond investors first to prevent defaults on debt obligations. While the Treasury may technically be able to pay bond investors ahead of others, it’s unclear if the Treasury has the legal ability to do so. The move would be challenged in court. Bond investors unsure how to resolve the legal uncertainty would demand much higher rates.
And politically, it seems inconceivable that bondholders, which include many foreign investors, would get their money before American seniors, the military, or even the federal government’s utility bills. At least not for long.
Other proposed debt limit workarounds, like minting a $1 trillion platinum coin, are also impractical. Federal law gives the Treasury the authority to mint platinum coins, and the thought is that the Treasury would mint a $1 trillion coin, deposit it with the Fed, and draw from it to pay the government’s bills. But the law approving platinum coins provided for commemorative coins without circumventing Congress’ power over the purse. It would also put the Fed in the middle of the fray, heavily politicizing the central bank and seriously jeopardizing its independence, which is vital to a well-functioning economy.
Some argue that President Joe Biden should invoke Section 4 of the 14th Amendment and direct the Treasury Department to continue issuing bonds and paying bills. The 14th Amendment states that the “validity of the United States’ national debt . . . shall not be called into question.” But this amendment was passed shortly after the Civil War to ensure the federal government was not on the hook over the Confederate states’ war debt. Investors would rightly wonder whether applying the amendment to repeal the Debt Limit Act would stand up in court, and even if it did, what that means for the check and balance of our political system. Given the constitutional crisis that would be triggered, financial markets would remain in turmoil and a recession would likely follow.
It remains unclear how lawmakers will resolve the impasse. Given the high economic and political costs of breaching the debt ceiling, the most likely path is for lawmakers to get it back together just in time. That could include an agreement on the debt limit coupled with an agreement on the federal budget for the next fiscal year beginning Oct. 1.
However, the likelihood of lawmakers failing to reach an agreement before crossing the debt line is significantly greater than zero. The difficulties House Republicans had in electing Kevin McCarthy as Speaker and the terms McCarthy had to agree to to win the election — including a debt-limit battle with Democrats — do not bode well. It’s difficult to get legislation through the process, but getting highly controversial debt-limit legislation through Congress before violation occurs will likely be an uphill battle.
A cornerstone of the US economy and the global financial system is that the US government pay what it owes in a timely manner. The political venture over the debt limit is therefore painful to look at. If lawmakers are unable to raise, suspend, or abolish the debt limit before the Treasury Department makes a payment to bondholders or anyone else, the chaos in global financial markets will become unbearable. The US and world economy will quickly slip into recession. In the more than a hundred years since the debt limit came into force, lawmakers have heeded such dire warnings and acted. Let’s hope they do it again. Soon.