The U.S. hit the debt ceiling on Thursday, sending the federal government into a scramble to avoid a default scenario akin to a “global financial crisis,” as Treasury Secretary Janet Yellen described in a letter to Congress this week.
Established more than a century ago, the debt ceiling is currently capped at $31.4 trillion.
It is the legal limit the U.S. government is allowed to borrow to continue paying for its existing programs and obligations, including, but not limited to, “Social Security and Medicare benefits, military salaries, interest on the national debt, tax refunds, and other payments,” Yellen wrote.
After informing Congress that the U.S. has reached that statutory limit, Yellen said the government is taking “extraordinary measures” to avoid the catastrophic economic and financial fallout that would follow a default.
This puts pressure on lawmakers, who have to come up with some sort of package to raise the debt limit while agreeing on certain cuts to spending.
Exactly how they plan to do that is a matter of some concern, given the incompatibility of the House Republican stance and that of the White House.
In the meantime, the government has pledged to redeem existing and suspend new investments of the Civil Service Retirement and Disability Fund and the Postal Service Retiree Health Benefits Fund, while suspending reinvestment of the Government Securities Investment Fund of the Federal Employees Retirement System Thrift Savings Plan, Yellen wrote.
Amid all this wrangling, Nancy Kimelman, assistant teaching professor in economics at Northeastern, says it’s important to keep in mind that, while governments have certain tricks, their ways of staying solvent are functionally no different from the ways households and businesses stay afloat.
“The government is no different from you or me,” she says.
Kimelman says there are three methods the government has to address the debt crisis: raising taxes; borrowing money and issuing debt; and cutting government spending.
The government borrows a substantial amount of money every year—some of which come from U.S. citizens.
“The problem is that we, American citizens, have lots of other options as to what we could do with our wealth,” Kimelman says. “We don’t necessarily have to lend our money to the federal government.”
“So the U.S. government does have the ability to borrow from the American people,” she continued. “The problem is on the margin, when they have to go out and borrow more than they expected—and more than people are necessarily willing to lend—and they have to raise interest rates to entice people to do that.”
The downside of government borrowing, Kimelman says, is that it puts “upward pressure on interest rates.”
“And, of course, we know that has a negative effect on the economy,” she says.
As it stands, the federal government spends far more than it raises in revenue each year. And increasingly, U.S. debt is being purchased by foreign investors.
“If that money did not come into the United States, if foreigners did not want to buy U.S. Treasury bonds, that money would have to be raised, again, either by convincing the American people to lend them money, or the government would have to raise taxes,” Kimelman says. “And that fact is what’s missing from the conversation.”
Another problem is that the other levers of government—raising taxes and cutting spending—aren’t politically appealing either. This disconnect leads to tension that all but ensures that fights over the debt ceiling will continue into the future.
“Somehow, there’s a willingness on the part of some people not to want to recognize that stark reality: that there is no magic bullet for the government,” Kimelman says.
As a result, Kimelman expects that congressional leaders will find their way through, noting that a default would be “unthinkable.”
“They’ll push for something that calls for some cuts in government spending,” Kimelman says. “In the meantime, the Treasury will find money somewhere so that people continue to get paid.”
Written by Tanner Stening.
