Is the newest debate over the debt ceiling more than hot air?

Is the newest debate over the debt ceiling more than hot air?

Some have labeled it “debt roulette,” but the routine congressional clash over extending the federal debt limit might be better described as a game of chicken. Picture a pair of buses carrying the leaders of the two major parties, hurtling at each other on a collision course while the rest of us can only stand at the side of the road and sweat it out. If they crash and don’t lift the debt ceiling, the U.S. will not be able to pay its bills. That will hurt the credit of the United States and raise the cost to taxpayers of borrowing.

In the latest iteration of this long-running, on-again, off-again staring match, Democrats seek to raise the debt ceiling to enable the U.S. Treasury to borrow enough money to pay for the spending Congress has already approved. Republicans threaten to block raising the limit to try to force Congress to make changes to the budget that Republicans were unable to change during the budget process.

Kathleen Day, a business journalist and author and a lecturer at the Johns Hopkins Carey Business School, specializes in the nation’s financial workings, particularly in times of crisis. In the following Q&A, Day offers her insights into the debt limit issue and its history. She addresses topics that include the origins of the limit, the impact on the economy if the U.S. were ever to default on its debt, and the related legacies of Alexander Hamilton and Thomas Jefferson.

QUESTION: The U.S. government has carried debt since the Revolutionary War, but the U.S. debt limit is a creation of the 20th century. How and why did it come about?

KATHLEEN DAY: Until World War I, Congress approved not only spending but essentially any instance of the U.S. Treasury’s issuing debt to finance that spending. In 1917, Congress changed that by lifting the requirement that it approve every bond Treasury issued to fund the war. But it did set limits on the amount Treasury could issue, and in that way retained control over the process. Then, at the end of the 1930s, Congress lifted the requirements that it had to approve Treasury’s issuance of debt to fund other spending that Congress had already approved. It again set a limit – a ceiling – on overall debt to maintain control. That’s the system now in place. 

Key to remember is that the debt ceiling is a cap on borrowing to be issued for spending that Congress has already approved, including, for example, money for Social Security and Medicare payments and veterans’ retirement funds. Approving an increase in the debt ceiling does not mean approving new spending. It merely enables the Treasury Secretary of the United States to fund debts that Congress has already approved, incurred, and promised to pay. 

It’s all part of a complicated dance involving:  

• deficit, which is the government’s shortfall in a given year between income from taxes and obligations it must pay, thus requiring borrowing via U.S. Treasury securities 
• debt, which is the accumulated amount of U.S. borrowing over the years and which has a cap that Congress can raise or lower 
• budget process, where Congress and the president decide how much to spend in a given year though taxes and, if there’s a shortfall, through borrowing 
• appropriations, in which Congress okays the money to fund the budget 

If the debt limit were not raised and the government were to default on its financial obligations, what would the impact be on the U.S. economy?

It would be a disaster, as U.S. debt securities, despite all our bickering, remain the benchmark of financial security worldwide. If we were to default, that underpinning would be lost, markets would plunge, and economies here and abroad would suffer. The cost to taxpayers to fund future expenditures would skyrocket. Unemployment would jump—Moody’s, for example, recently estimated that 6 million jobs would be lost, nearly doubling the current unemployment rate of 5.2% and erasing $15 trillion in household wealth, if default occurred.

Retirement checks for veterans and Social Security recipients would be interrupted. The cost of borrowing for homes, cars, and credit cards would explode. In short, default would cause mayhem – so much mayhem, in fact, that I think elected officials would blink before they would let it happen.

Still, Congress’ let’s-take-us-to-the-brink-before-we-blink tactics have potential costs. In 2011, during the Great Recession, just after Republicans and Democrats reached a debt ceiling agreement, Standard & Poor’s nonetheless downgraded the U.S. credit rating, citing the “political brinkmanship” as an element of risk that could not be ignored. That downgrade highlights how such a move comes at taxpayer expense. For taxpayers, political uncertainty can raise the cost of borrowing as investors demand higher returns to compensate for the higher risk of default uncertainty.

Another key ratings agency, Fitch, in a recent report, cited the bitter political division that followed the 2020 presidential election as a troubling circumstance that could lead it to downgrade America’s credit rating, and thus raise borrowing costs for taxpayers, with or without a debt ceiling. In other words, the stability of America’s democratic institutions has an even greater impact than the debt ceiling on the country’s ability to borrow and maintain its good name in markets.

In an interview with Marketplace, you referred to the “political football-ness” of debt.  What did you mean?

With or without a debt ceiling, politicians of both major parties will find a way to make funding America’s debt political. For example, the Republican tax cuts of 2017 raised the deficit – the amount by which expenditures exceed taxes and other sources of funding and thus create the need for the government to borrow – by an estimated $1 trillion over the next decade, despite promises that the cuts would pay for themselves. The deficit grew by nearly $8 trillion under Donald Trump, even before COVID-19 hit. Republicans then used the increase in the deficit that their tax cuts helped create to call for cuts in spending, specifically in Social Security and Medicare. Now Republicans want to push for more tax cuts for the wealthiest, with no plan for how to make up the increased shortfall, which will put further pressure on Social Security.

Recall that Republicans didn’t expect the pandemic to come along and bring with it a recession. When COVID-19 hit and sparked a downturn, it scuttled talk of cutting Social Security and Medicare and, to the contrary, required massive additional government spending to keep the economy afloat. The total deficit was $2.8 trillion in fiscal 2021, its second-highest total ever, and largely driven by spending to counteract the economic drag of COVID-19.  That pushed up the already-big national debt even more, to over $28 trillion. It’s now bigger than ever – over $36 trillion – well over the debt ceiling of $31.4 trillion, because Congress agreed in 2023 to suspend it until January 1, 2025. Now lawmakers again have to play chicken or cost taxpayers billions in additional borrowing costs.

The current Treasury Secretary, Janet Yellen, has called the debt limit concept “destructive” and has said she would support legislation to abolish it. Do you agree that the debt limit should be abolished, or does it serve a useful purpose?

Personally, I think the debt limit, though routinely misused by both major parties, is as good as anything to remind the public of the enormous public debt we carry. Any substitute, including lifting the ceiling permanently, would not do away with the political shenanigans and grandstanding surrounding the national debt. Keeping a ceiling helps remind everyone of the enormous burden our debt is, to the current economy and to future generations.

According to the Congressional Research Service, foreign governments (led by Japan, China, and the United Kingdom) and foreign private interests held 29% of the publicly held U.S. debt as of December 2023, and the interest paid on the debt to foreigners in 2023 was $197.5 billion. Can you provide some context for these numbers? In financial terms is it largely a beneficial arrangement for the U.S., or is it more like a ticking time bomb?

Both. Having many groups willing to extend credit to you lowers the cost of borrowing. But being indebted can be a ticking time bomb. It depends, as with most things in life, on degree. If you borrow to buy a house and do so at prevailing market rates and for an amount you can afford, homeownership can be beneficial, for example, if you pay off your mortgage and fully own your house when you retire. But it is not beneficial to buy a much bigger home than you can afford, so that all your money goes to the mortgage and interest on that mortgage, taking money from the economy that could be spent more productively on other goods and services. Borrowing can be good if the benefits outweigh its costs. Too much borrowing is corrosive.

Here’s a real-life example of the national security risks that come from being heavily indebted. During the Great Recession of 2007 to 2012, Russia and China held about $500 billion, or 10%, of U.S. mortgage debt. When the mortgage market crashed in 2007, Russia approached the Chinese to try to coordinate a mass sell-off of that debt to flood the market and plunge U.S. markets even deeper into chaos. China declined, but the threat underscored the risk of owing so much money.

How much debt is appropriate to be held by foreigners? There’s no consensus, but many economists seem to agree that the overall debt is the problem, not necessarily who holds it. Today’s 29% of foreign ownership is down from 49% in 2011.

Alexander Hamilton called federal debt “a national blessing” that would help the nation and its economy grow. About four decades later, Andrew Jackson referred to debt as “a national curse” that primarily benefited the wealthy. Whose evaluation would you say has proved closer to the mark?

Both were right, but framing the debate as one between Hamilton and Thomas Jefferson is more useful than framing it as one between Hamilton and Jackson, who was just too irrational on this issue, which some attribute to his family’s run-in with creditors.

Jefferson understood that debt, like banks, could be useful but also destructive. He felt that the risks too often outweighed the benefits. Hamilton also understood the potentially destructive power of debt and banks, but he understood that the ability to borrow – and the need to maintain a good credit rating to do so – was imperative for economic growth. Imagine if every company had to save up money before buying equipment or investing in research for new products and services. That would severely hobble economic activity.

Too much debt, however, as we’re seeing in the high-risk corporate debt arena now, can be corrosive and counterproductive. Just like an individual, a company burdened with too much debt is spending too much money on interest rather than on investments for its future. The benefits of debt must outweigh the inherent potential risk of owing someone money. It is beneficial to borrow to build a factory that makes widgets that people want to buy, that helps employ people, and helps the economy grow, hopefully long after the debt of building the facility is repaid. But companies that are overextended, just like overly indebted individuals or governments, become buried in debt.