Also known as the debt limit, the US debt ceiling is a limit set by the American Congress on how much the US Government is allowed to borrow
As part of the Second Liberty Bond Act of 1917, the United States Congress established a $15 billion debt ceiling, providing a process to control the amount of US Government bonds the country could issue. Prior to 1917, Congress needed to pass a legislative act that approved the amount and purpose of each debt issuance.
In 1939, the Public Debts Act was passed, which created a limit on all federal debt, eliminating separate limits on individual forms of debt. However, this limit has not remained fixed. According to the US Treasury, since 1960 the US Congress has raised the debt ceiling on 78 separate occasions. It has never reduced the ceiling.
The debt ceiling was established to create a more efficient way to finance the US government’s outstanding financial obligations, as well as a way to prevent runaway debt raising.
Government spending and the debt ceiling are two distinct concepts. Government spending refers to the new commitments made by the government for various activities such as defense, education, and infrastructure. On the other hand, the debt ceiling represents the total amount of debt accumulated by the US government to finance both current and past obligations that surpassed the government’s revenue, known as the budget deficit.
The fiscal deficit of the US was $1.38 trillion in 2022 and the US has approximately $31.5 trillion in outstanding total public debt as of May 2023.
Think of the debt ceiling like a credit limit on a credit card — just as you have a limit on the amount of money you can borrow, the U.S. government has a limit on the amount of money it can borrow to fund its spending.
As of May 2023, the US debt ceiling stood at $31.4 trillion, which was the limit set by the Biden government in 2021. However, a bill passed in June 2023 has suspended the debt limit until 2025.
Once the government hits the debt limit, in theory it can no longer borrow and since the US runs an annual fiscal deficit, that means it may soon run out of money and might temporarily default on its obligations, including paying government staff and military personnel.
Failure by the US Treasury to raise additional debt to cover interest payments on its existing debt could result in a default on the government’s debt obligations. This would have severe repercussions for the US economy and global financial markets, potentially leading to a credit rating downgrade and even a government shutdown.
Changes to the debt ceiling require majority approval by both Congress and Senate, so it is a politically difficult thing to do. While members of both parties have acted quickly in some instances, there is always brinkmanship and political posturing involved. For example, in 2011, a standoff between President Obama’s Democrats and the Congressional Republicans only reached a deal to raise the ceiling two days before the date that the Treasury forecasted it would run out of money.
The frequency at which the US Congress passes a debt ceiling increase can vary widely depending on a number of factors, including the political climate, economic conditions, and the level of national debt. In recent years, the frequency of debt ceiling increases has increased due to rising levels of national debt and political gridlock in Congress.
As of late May 2023, the US didn’t have a debt limit increase agreement between the two parties.
House Speaker Kevin McCarthy indicated that he and his fellow Republicans are planning to use the debt limit standoff to push through their agenda of spending cuts and national debt reduction, as well as other non-financial agenda items like crackdowns on illegal immigrants.
Meanwhile, President Biden and his Democratic lawmakers insisted on raising the debt limit with “no strings attached”.
Treasury Secretary Janet Yellen warned that a default could happen as soon as June 2023. Known also as the “X-Date”, that would be the day the US government runs out of money to pay its obligations.
However, on June 5, President Biden signed a bill passed by both the US House of Representatives and US Senate after much standoff between the two parties. This bill suspends the debt limit until 2025 – after the next presidential election – with some restrictions on government spending over the new two years.
Yes, a default is very serious. Using our credit card analogy from earlier, that would mean the creditworthiness of the world’s largest economy would be called into question.
Not only would the borrowing costs for the US government skyrocket, but all borrowing costs for US businesses and households would also jump. Researchers estimate that the national debt would increase by $850 billion in debt servicing costs and an average mortgage loan would cost an additional $130,000.
A prolonged stalemate or potential default of the US government would also impact its credit rating. The US government has had its credit rating downgraded only once in history, and that was in August 2011, by the credit rating agency Standard & Poor’s (S&P).
At the time, the US was also in the midst of a debate over raising the debt ceiling, and S&P cited the political gridlock and uncertainty surrounding the issue as the main reason for the downgrade. S&P lowered the U.S. government’s long-term credit rating from AAA to AA+, which is still considered a very high credit rating but was the first time the US lost its AAA rating from S&P.
The negative impact would also extend to investors globally, as we saw in the 2011 standoff. Stock prices fell, and market volatility spiked as investors tried to find safe harbors to park their investments.
The US economy would also suffer, with as many as 3 million jobs lost in a “self-inflicted economy catastrophe” and more harmful to the US economy than the 2008 Global Financial Crisis. If a “Biden Default” were to happen, Goldman Sachs chief US political economist, Alec Phillips, estimates at least a 10% hit to the US economy.
Holders of US government debt, including the foreign governments of China and Japan, may also look to offload some of their holdings, which could cause a massive calamity in fixed income markets. Lastly, the US dollar, which has been the safe haven currency and global reserve currency and monetary unit, will also lose some of its luster.
This “risk-off” sentiment may be positive, however, for precious metals and other commodities. Other government bonds in the Eurozone may also benefit. And finally, it is also entirely possible that cryptocurrencies may benefit as investors look to move away from centralized traditional fiat currency into decentralized digital currency.
Whatever the outcome of a potential US government default, it would certainly be a financial catastrophe, which means the stakes are even higher for both sides to find a resolution.
There are some things that the US Department of the Treasury can do to ensure that the US government doesn’t run out of money before Congress passes an increase, albeit only for a short while.
The US Treasury can use so-called “extraordinary measures” to delay the breach of the debt ceiling. These measures include temporarily suspending investments in certain government funds and programs and delaying the issuance of new debt. These measures can provide some additional time for the government to operate under the existing debt limit.
It may also prioritize its spending to ensure that debt service obligations are met. This means that if the debt ceiling is reached, the government can prioritize payments to bondholders and other creditors to avoid defaulting on its debt. This can help prevent a crisis while Congress works on passing a debt limit increase.
Congress may also choose to temporarily suspend the debt ceiling or allow the Treasury to go over the limit in order to provide additional time for negotiations and prevent a breach of the debt ceiling. This has been seen much more commonly of late, with Congress suspending the debt limit seven times in the past decade — the latest being the Bipartisan Budget Act of 2019, which suspended the debt limit until July 31, 2021.
The US government can also work to reduce spending and/or increase revenue to decrease the need for borrowing. This can be achieved through a variety of policy measures, such as spending cuts, tax increases, and economic growth.
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