The American Debt Ceiling – A Reoccurring Political and Economic Issue | June 5, 2023

Introduction – What is a National Deficit?
Like a household that budgets living expenses against the income its members earn from work, savings and investments, national governments also must budget their expenses during a period against the revenues it generates in that period. A budget deficit occurs when the money going out (spending) exceeds the money coming in (revenue) during a defined period. The opposite of a budget deficit is a budget surplus, which occurs when the federal government collects more money than it spends. A government typically collects money through taxes; in the US half of federal revenues come from individual income taxes, while corporate income tax, sales tax, customs duties and payroll tax makes up the remaining revenue. In turn, the US government primarily spends money on Social Security, National Defense, Medicare, Interest on its debt and assistance to its individual states.

Importantly, the US has long operated in a regime where its total spending exceeds its total revenues resulting in a national deficit which currently stands at US$1.38 trillion per year. When a national government operates in a deficit, it must borrow money through the issuance of bonds, bills and other securities; that is a nation must increase the total amount of national debt to fund its deficits. The national debt is an accumulation of national deficits over time and the United States’ national debt currently stands at US$31.47 trillion or 124% of GDP.

The Debt Ceiling
In 1917 ahead of the First World War, the United States acted to provide more flexibility to aid its involvement in the war by modifying how Congress authorized the issuance of new debt. Under this new act with greater flexibility to increase the national debt, Congress also established an aggregate limit (ie. A ceiling) on the total amount of new debt that could be issued in the form of Liberty Bonds. This concept was further expanded in 1939 to cover all debt instruments that could be issued at an aggregate limit of $65 billion. As the United States funded its deficits through the Second World War, the limit was raised to $300 billion by 1945. After relative stability in this limit through the 1950s, the US has since raised the ceiling 74 times from 1962 to 2011. Despite the debt ceiling being raised frequently, the issue often time comes with much political friction, tension and potential economic impacts.

For example, in 1995 the United States Federal Government was shut-down due to the conflict between the Democratic President Clinton and the Conservative Republican Congress who threatened to not raise the debt ceiling while demanding a smaller Government with less federal funding for items such as education, public health and the environment. The ceiling was eventually raised after a revised spending plan proposed by Clinton and the government shutdown was resolved.

In 2011, a very similar situation happened where Republicans in Congress once again used the debt ceiling as leverage for deficit reduction, however, the fallout from this conflict was more severe than in the past. During the crisis, the United States came within two days of reaching the existing limit which would have resulted in the Treasury having no option but to either default on payments to bondholders or to immediately cut payments of funds owed to companies and individuals mandated by Congress; both options would lead to severe international financial implications.

Following the resolution and raise of the debt ceiling on July 31, 2011, the national debt rose $238billion (or about 60% of the new debt ceiling) on August 3, the largest one-day increase in the history of the United States. The US debt surpassed 100% of GDP for the first time since World War II. Additionally, the agreement involved significant budget cuts which immediately lead to the largest drop in equities markets since the Great Recession. On August 5th, 2011 the Standard & Poor’s credit rating agency downgraded the long-term credit rating of the United States government for the first time in its history, from AAA to AA+. The 2011 debt ceiling crisis had the most severe impact on Global markets when compared to any other prior contention around the debt ceiling in the past.

Since 2011, debt ceiling issues have frequently occurred with further crises happening in 2013, 2021 and most recently in early 2023. On January 19th, 2023, the United States hit its debt ceiling leading to a new crisis. The Treasury enacted extraordinary measures in order to avoid a US default on its outstanding debt that was anticipated to be exhausted by June 5th, 2023. On June 3rd, 2023 President Biden reached an agreement with the Republican House to raise the ceiling but to cap federal spending to avoid a crisis.

What do Debt Ceiling Crises mean for Global Finance?
The United States continues to operate in a deficit and continues to grow national debt and as a result, the debt ceiling issue will continue to exist. Generally, both parties in the US Government agree to raise the debt ceiling without much conflict, in situations like the most recent debt ceiling conflict, the possibility does exist for global financial market distress.

Should the US breach the debt ceiling and default on its debt obligations, Mark Zandi, Chief Economist of Moody’s Analytics, predicted that even with a brief default, a “crisis, characterized by spiking interest rates and plunging equity prices, would be ignited. Short-term funding markets, which are essential to the flow of credit that helps finance the economy’s day-to-day activities, likely would shut down as well.” In more real terms a short default could cause a decline in GDP cause up to 2 million job losses and significantly affect the current position of US debt as the lowest-risk global financial instrument. While the debt ceiling is an ongoing issue that grabs significant news coverage due to the nature and severity of the potential consequences, it must be noted that the ceiling has acted in the way originally intended; to regulate US government spending and to keep the US government more fiscally responsible than it would be without it. Additionally, the ceiling has been raised throughout any conflicts between parties with no signs of Congress moving on to any alternatives. The biggest risk around the ongoing debt ceiling debates seems to be general volatility in markets or further downgrades of the long term credit rating of the country by the various rating agencies.