America has a debt problem, but the problem is not the debt itself. It’s the debt ceiling. A breach of the US debt ceiling would herald chaos. It is the only obstacle that might prevent the US from paying its debt payments on time. On a technical level, a breach would result in the cessation of borrowing by the US Treasury. Since the US is running a budget deficit, a cessation in borrowing would lead to a government loan default. Increased partisanship in Congress intensifies the incentives to participate in financial brinkmanship around the debt ceiling. The more partisan our politics, the more likely a debt ceiling crisis is. Americans should not let polarized politicians play chicken with the global economy.
The debt ceiling is the limit on the amount of debt that the federal government is legally allowed to carry at a given time. When the government gets close to the limit, Congress has to raise the limit so that the US does not default on its obligations. The debt ceiling is always for show. Nobody really wants the US to default on its obligations. The tacit purpose of the debt ceiling is to remind politicians of fiscal responsibility by periodically forcing them to raise the ceiling. Eventually, both sides must raise the ceiling to avoid default. The spectacle that surrounds raising it is just that: a very dangerous spectacle. There are much, much better ways to motivate fiscal responsibility than a hard ceiling that could blow up the global financial system if politicians decide to take their brinkmanship too far. And the low-rate environment means the “fiscal responsibility” looks a lot different, and less austere, than one might imagine.
The US has not had a budget surplus since 2001. A deficit, however, is not a problem. As long as interest rates remain low, the government can support far more debt than already exists. The economic research suggesting a positive relationship between government debt and interest rates has not materialized in reality: the deficit blossomed under President Trump, but rates remain at historic lows. The biggest shift in policy that has occured between 2009 and today is nearly wholesale rejection of austerity as good economic policy.
The GOP used to tout fiscal conservatism as its backbone, but with its populist base, fiscal conservatism does not drive Republican voters like it used to. Reaganomics might be gone for good even if it never existed, even under Reagan. Many fiscal hawks in Congress are really fiscal vultures who, according to Nobel-winning economist Paul Krugman, “exploit real or imagined fiscal distress to feed a reactionary policy agenda.”
Fiscal conservatism didn’t stand a chance against the populist policies of President Trump. In 2019, Congress suspended the debt ceiling until August 2021 in a bipartisan deal. With the deal, Congress avoided a pre-election showdown. But while the debt ceiling remains a feature of the US government, so does the eventuality of a showdown. There might be a return to fiscal conservatism in the post-Trump GOP, but such a return would be more political than ideological as most congressional Republicans have already revealed their true colors by falling in line behind Trump’s deficit-expanding policies.
Today, Republicans and Democrats alike admit that the 2009 stimulus package did not go far enough to address the Great Recession. While the GOP is still the home of fiscal hawks, those hawks find themselves in a caucus that no longer consistently shares their beliefs. The “crowding out” effect of government spending that fiscal hawks decried has not come to pass. Public and private investment, economists found, is not zero-sum. Because investment begets investment, government spending actually has a “crowding in” effect. Austerity does not create economic growth. Economists since Keynes have spoken and the government listened. Spending is good, and with rates this low, it’s great.
Default, on the other hand, would spell disaster. The economic power that the US enjoys is largely reputational. The word “credit” comes from the Latin credere, to trust. Holders of US bonds trust that the US government will make good on its promise to pay them back. If the US did not pay back those bondholders, then the interest rate, or yield, on US government bonds would increase because as risk increases, so do rates. Since so many securities are tied to the US bond market in one way or another, this would lead to a broad market rate increase. US creditors that made decisions about their financial security based upon the assumption that they could trust the US to pay its bills would be out of luck.
Japan, for example, owns over $1.27 trillion in US government debt and is the largest foreign holder of that debt. If the US were to default, Japan would suddenly face its own economic crisis. The UK, with over $400 billion in US government debt, would also face its own crisis. Plenty of countries beyond just these two would face severe economic shortfalls, and the domino effect would be brutal.
Default is only the worst case scenario. The high-stakes battles that surround debt ceiling increases can be detrimental to the economy without actually defaulting. If lenders think the US is even at risk of defaulting on its loan obligations, then the government’s credit rating can be downrated. This, in turn, increases the government’s cost of borrowing. Standard and Poor’s actually took this step and decreased the rating from AAA to AA+ during the 2011 Debt Ceiling Crisis.
More expensive government debt does not just affect Congress’s purse strings but also plenty of everyday Americans who hold government bonds in their pensions, 401(k)s, IRAs, and personal accounts. It is generally fiscal hawks who slow down debt ceiling negotiations, but the very act of slowing down the process can make deficits worse because they reduce creditworthiness and thereby increase the cost of debt, which is the effective interest rate that debtholders pay. The cost of debt on a home mortgage, for example, is the interest rate you pay on that loan. US government debt is the universally-accepted “risk-free” investment. What happens if the risk-free rate stops being risk-free? Increasing the US government’s cost of debt can affect the rates for mortgages, credit cards, car loans, college loans, and more.
Even if the debt ceiling is reached, the country will not immediately default. The Treasury is empowered to take “extraordinary measures” to avoid default if the ceiling is reached. This isn’t just a government shutdown, where the government is unable to make future obligations. A debt ceiling shutdown means that the government cannot meet current obligations, which makes the situation much stickier.
In this scenario, the US government must prioritize which debts to pay off and which to default on. The government will be forced to ask which is more important: paying government employees’ pensions or paying off loans to China? It’s a question that nobody wants to answer.
If lawmakers want to keep debts low, they can do so through the annual budgeting process. Or they can set automatic increases to the debt limit as Congress spends more money. Either way, there’s no need to risk the global economy so that fiscal hawks can be quoted on the front page of the Wall Street Journal pontificating about “responsibility.” There are a lot of countries that get by just fine without a debt ceiling. In fact, the US and Denmark are the only democracies with debt ceilings, and Denmark’s ceiling has always been set far above that country’s actual debt level. America, too, can get by just fine without its debt ceiling.
Photo: Sharon McCutcheon on Unsplash