America has found herself in quite the financial pickle. As the government shutdown drags on, and the country continues to operate without a budget, we are simultaneously getting closer and closer to reaching the national debt limit. According to Jack Lew, Secretary of the Treasury Department, the United States will run out of money on October 17th, about ten days away. Now, Congress must not just decide on a budget for the upcoming fiscal year, but decide whether or not they want to raise the debt ceiling, or default on our national loans. Neither option is a good one, and both could, potentially, have disastrous consequences for the nation’s hope for economic recovery.
What is the debt ceiling?
The debt ceiling, or debt limit, is the legislative limit on how much debt the national Treasury is allowed to issue. It doesn’t prevent the United States from taking on debt, but rather limits America’s ability to pay for existing obligations =.
Think about it this way. If you reach your personal limit on a credit card, you can continue to buy things on credit using a different card. However, the more bills you rack up, the harder it will be to pay off your existing expenses. The American debt limit works similarly in the fact that we can continue to borrow money more or less indefinitely, but that will make it more and more difficult to fund existing government expenses since we will simultaneously have to be paying back interest on these extra loans.
Raising the debt limit is the equivalent of taking out another credit card to continue to spend money. Defaulting means that instead of taking out more credit or loans, you are refusing to pay the interest on the loans you already have. As you can see, neither of these solutions are sustainable, or good for your, or the country’s long term finances.
Have we raised the limit before? Have we defaulted before?
The debt limit wasn’t instated in the United States until 1917, and even now we are the only country in the world where legislating for the debt limit has become a national issue.
In 1979, in order to make things more streamlined, Dick Gephardt issued the parliamentary process known as the “Gephardt Rule” which insisted that Congress vote to raise the debt limit at the same time they voted to pass a budget. This prevented the problem of passing a budget while not authorizing the debt required to pay for it. In 1995 this rule was revoked, which led to the 28 day government shutdown of that year.
In summer of 2011, Congress delayed in passing legislation to raise the debt limit. This delay caused the United States to get dangerously close to defaulting on our loans, directly leading to the first ever downgrade of American credit. The United States was downgraded from a credit rating of AAA (outstanding) to AA+ (excellent) on August 5th, 2011.
This delay in raising the limit also caused the Dow Jones Industrial Average to have one of its worst days on record and for stocks across the board to drop significantly. Furthermore the delay is estimated to have cost the federal government $18.9 billion over ten years due to extra borrowing costs.
So what’s happening with the debt limit now?
The United States reached the current debt limit of $16.394 trillion on the first of the year 2013. Since then, the Treasury Department has taken extraordinary measures to prioritize payments until Congress could decide legislatively what to do. On May 19th, 2013, Congress voted to raise the debt limit to $16.699 trillion to buy some time. It is that limit which we are set to reach on October 17th.
What will happen if Congress fails to act?
If Congress fails to raise the debt ceiling and the Treasury Department is forced to exhaust extraordinary measures, there could be disastrous implications for the economy. The Treasury would be forced to delay payments, placing a freeze on seven percent of the nation’s GDP. This fiscal squeeze would cause a recession worse than the Great Recession of 2008.
Both domestically and internationally, the value of the dollar could fall if it became clear that the government could not pay its debts and and does not have the cash on hand to honor Treasury bonds. This could put a freeze on bank lending and the credit markets.