The US debt ceiling, or debt limit, is a legislative cap on the amount of debt that the United States government is authorized to borrow. More specifically, it is the maximum amount of debt that the United States Department of the Treasury can issue to investors or to other US federal agencies in order to finance the legal obligations of the US Government, including Social Security, Medicare benefits, military salaries, interest on existing debt and other payments.
The reason that this is important for markets is that politicians may use tactics to delay legislation designed to amend the debt ceiling in order to apply pressure on their political opponents, called filibustering. The resulting uncertainty and negative headlines about potential government shutdowns, spending cuts, and potential default can rile the capital markets, at the same time diminishing the confidence of US Treasury securities, such as Treasury Bills, Notes, and Bonds.
Not The Same As a Credit Card Limit Nor a Spending Cap
Some explain the debt ceiling as akin to a credit card limit but that’s also not technically correct since a credit card limit is set by the lender but the debt ceiling is a borrowing limit set by the borrower, the US Government in this case.
It is also important to note that the debt ceiling is not a limit on government spending, but rather a limit on the amount the government can borrow. Spending would have already been authorized by Congress and the debt ceiling dictates how much money the US Treasury can borrow to pay for these expenditures.
The US Government’s Daily Cash Shortfall
The financial obligations and cash flows of the US Government are made publicly available every day by the US Treasury in the form of their Daily Treasury Statement. On the income side of the ledger, the federal government takes in mostly taxes but runs a substantial shortfall to pay for all the expenses involved in running the country.
For example, on October 1, 2021, the first day of the US Government’s fiscal year, the daily shortfall was approximately $82 billion dollars. The running total of the nation’s debt is also outlined on the same Daily Treasury Statement and stood at $28.4 trillion. However, the debt limit that the government is authorized to borrow as set by both houses of Congress is $22 trillion presently.
The Congressional Budget Office, a non-partisan agency that provides independent analysis of financial forecasts and budgets for Congress, forecasts that the amount of debt that is captured by the debt limit will approach $34 trillion by 2026 and over $40 trillion by 2031 based on projected spending.
Increasing The Debt Limit
So you might notice that the amount of money that is outstanding exceeds the amount of the debt ceiling. This is not uncommon in the history of the United States. As a matter of fact, since the end of World War II, Congress has voted to modify the debt limit some 98 times – 21 times since 2001. These increases allow further borrowing by the country and federal operations to continue normally.
Nonetheless, Congress could choose to leave the debt ceiling in place either on purpose or by blocking legislation to increase the limit for political reasons. However, this may have negative consequences, such as:
Higher borrowing costs for the US Treasury as investors lose confidence;
Market uncertainty and disruptions for markets as fears of default creep in;
Potential interest penalties from delay of federal payments and transfers; and
Downgrades of the US Government’s credit rating by external rating agencies.
What Else Can Be Done?
Apart from providing legislation to permanently modify or increase the debt limit, there are also other actions that can be undertaken by both Congress and the US Treasury to keep the government below the debt ceiling.
Congress could temporarily suspend or even abolish the debt limit. A recent example is the Bipartisan Budget Act of 2019. This act was passed after months of negotiations in both Houses to boost funding across military and non-military spending, prevent large spending cuts, called sequestrations, and to suspend the limit for two years through July 31, 2021.
While many talk about the US “defaulting” on their obligations, so far the US has never missed a payment on their debt obligations, despite political wranglings.
If instructed to do so by Congress, the US Treasury also has options that it can exercise that may allow it to finance the government’s activities for a limited time without an increase to the debt limit. These are known as “Extraordinary Measures” and include short-term solutions such as delaying investments to government stability funds, contributions to civil service employee pension plans or in the worst case, even borrowing from those funds.
Trillion Dollar Coin
One of the more bizarre ideas that is discussed in the news whenever the US Government runs into their debt ceiling limit is the trillion dollar coin. The theory is that the President of the United States could order the Treasury Secretary to mint a single $1 trillion dollar coin out of platinum.
The reason why the theory calls for a platinum coin is that the US Treasury is limited by law on how much paper and gold, silver and copper coins that can be in circulation at any given time, but not platinum.
Once minted, this coin is then deposited with the Federal Reverse and seemingly out of thin air, the US Government would have an additional $1 trillion to pay off its obligations, avoiding the debt ceiling since the government has just created a trillion dollars without additional borrowing.
It is important to note that this idea is purely hypothetical as it might potentially create harmful levels of inflation, reduce the ability of the US Treasury to fund itself and create a political nightmare as the President would have compromised the independence of the US Federal Reserve, which is entrusted with making monetary policy decisions without political interference.