What is
the debt ceiling?
The debt ceiling is a self imposed limit for US Government
borrowing. How much the US can borrow is set by legislative procedure. Both
houses must vote and determine a limit. Currently, that limit is nearly $17
trillion. That limit ran out in May 2013 but the US Federal Reserve has managed
to run the economy without borrowing more by using some other measures.
However, the Treasury Secretary has said that these measures will be exhausted
by Thursday and the Government will need to borrow more. With only a few hours
to go the Government must vote to increase debt ceiling.
Why
does the US keep hitting the debt ceiling?
Between
1940 and January 2013, the debt ceiling was raised 94 times. During President
Reagan’s term, the ceiling was raised 18 times – the maximum. And so far,
during President Obama’s term, it has been raised 6 times. You probably
remember reading about frequent debt ceiling debates in the recent past. What
has lead to this recent frequency of increasing the debt ceiling?
While
US has been borrowing for a long time, the recent events can perhaps be traced
back to the financial crisis of 2008. (Read a detailed explanation of that
crisis here) After the 2008 sub prime crisis
exploded, the US economy was weak and the Government had to revive it. It
decided to dole out money through stimulus packages. But the Government didn’t
have enough money in its kitty for these packages so it decided to print
dollars. Failing companies were given money to survive; people were given money
to spend. At that time, the crisis was controlled.
But the
doling out of money was just a temporary solution. It only prevented a further
fall. The fiscal stimulus did not help promote industry, did not help create
jobs. All this while, while the US Government did not earn much by way of
income, it still had the same level of spending to do to keep up the people’s
standard of living. Remember that the country also fought two expensive wars
during this period. All this lead to a widening deficit.
How
does the US Government fund the widening deficit? It can raise taxes or cut
spending but both are not very popular. It can also print money but it has
already printed a lot and printing more can cause inflation. The last option,
also the cheapest for the US, is to borrow and so the US borrows more and more.
Who does it borrow from? From its own people (internal debt) and from other
countries (external debt). The Government issues bonds to its people and to
other countries and raises dollars. Right now, the US is a AAA rated sovereign.
That means, it is has the best credit rating. People and countries believe that
the US will not default in repaying borrowed funds. Because of this rating the
US is able to borrow funds at a low cost. Countries like China that export
heavily to the US tend to accumulate huge dollar reserves. They lend those
dollars back to the US in exchange for treasury bonds.
Today,
the US has borrowed so much that it repeatedly hits the debt ceiling.
To put
it in numbers, here’s a look at the US economy (2012 numbers):
Total
Revenues: $2.45 trillion (mostly taxes)
Total
expenditure: $3.54 trillion (social security, defense, medicare, interest and
other expenses like crude oil etc)
Deficit:
$1.09 trillion
Accumulated
Public debt: $16.68 trillion
Why is
it so nail biting this time?
The US hit the debt ceiling in May 2013. But the Fed has managed
to run the economy without borrowing more by using some other measures.
However, the Treasury Secretary has said that these measures will be exhausted
by Thursday. In order to raise the debt ceiling, the House must vote. But this
time around, the Government is at an impasse. The Republicans and Democrats are
at war over Obamacare. Neither party is willing to negotiate. The Government
has been shutdown for the past few weeks because the two parties could not
agree to a Budget. Read more about that here.
According
to Moody's Analytics, a two-week shutdown would cut 0.3% off US GDP, while a
month-long outage would knock a whole 1.4% off growth.
As revenues
continue to deplete, the need to borrow more will only increase.
What
happens if the debt ceiling is not raised?
If the
debt ceiling is not raised, it means the US will not have money to bridge the
fiscal deficit. It will not have money to pay its bills. This also increases
the risk of default. A default means the US is not able to repay the principle
and interest on its borrowings. If the US defaults, it will hamper its credit
rating. Rating agency Fitch has already issued a warning on
the US credit rating.
We are
back to the game of wait and watch. Hope this helps in putting some perspective
into that game. Till next time, Money Happy Returns!
