By Robel Tadesse || Contributing Writer
Lawmakers seek bipartisan solution to avoid a default
Thirty-one trillion dollars – that was the amount of the debt ceiling set by Congress at the end of 2021. On January 19, the U.S. government reached the statutory limit. This in turn prompted the Treasury — the government adjacent body responsible for, among other things, issuing currency — to take so-called “extraordinary measures.” These extraordinary measures involve short-term accounting shifts so that the government can meet its existing obligations. They are short-term in the sense that the preventative effect would last until June of this year at the latest, at which point a longer-term solution would have to be instituted.
The debt limit is the amount of money that the government is allowed to borrow via the sale of bonds and other financial instruments (collectively called Treasuries) to finance its legal obligations like paying for salaries and Social Security. A bond is a promise to the bondholder (the lender) that the borrower will pay back the principal along with interest payments that are predetermined. U.S. Treasury bondholders comprise U.S. citizens, foreign nations, and any economic agents in between. The event where the government is unable to fulfill its promise to pay is known as a default.
A default would be catastrophic for two main reasons. First, it would mean that interest rates on consumer loans would increase rapidly, making purchases with debt (cars, mortgages, credit card transactions, etc.) more expensive. Business loans would also be harder to access and more costly, having the most-pronounced impact on small businesses. Second, a default would downgrade the credibility of Treasuries to foreign investors who normally consider these assets a haven. Relatedly, since the U.S. dollar is the world reserve currency, the threat presented to the global financial system in the event of a default is enormous and could trigger a financial crisis. Other possible scenarios include a challenge to the dollar as a world reserve currency which would displace the advantage the U.S. — and other dollar-denominated economies — currently enjoy; thus, a default would also have national security implications. Of course, all these deducible outcomes are hypothetical — since the U.S. has never defaulted on its debt before.
Albeit much less frequent, an increasingly popular course of action for Congress in the face of a looming default has been to temporarily suspend the debt ceiling, which would put the government at liberty to continue to borrow as needed. More commonly, Congress has resorted to raising the debt ceiling via legislation. Prior to the most recent ceiling adjustment, Congress has increased the cap some 78 times as the debt growth required modification. This growth can be accounted for by the budget deficit that has been characteristic of the government’s pattern of spending; since its revenues aren’t enough to offset expenditures, the government is forced to borrow to cover the amount of the deficit. A common criticism posed against the issuance of further legislation surrounding the debt ceiling is that doing so constitutes barking up the wrong tree. That is, some say, the debt ceiling is not the main issue that needs legislative action but the spending activities by the U.S. government that drive the deficit to reach such high levels in the first place.
But why is there a debt ceiling to begin with? To answer this question, it’s important to briefly consider the historical component of the debt ceiling in relation to the USD. The origins of the debt ceiling take us back to 1917 during the first World War. Formerly, the government needed approval from Congress each time it needed to borrow. To remedy this cumbersome process, Congress established the debt ceiling, through the Second Liberty Bond Act, which would serve as an aggregate limit on government debt. It is essential to note that this was practiced at a time when the dollar was a fixed currency – its value was fixed to the value of gold. Later, the Nixon administration would dissolve the gold standard and the dollar would become a fiat currency i.e., a government-issued currency that is not backed by a commodity (like gold).
Armed with this brief background, we can now return to our question. Conventional wisdom would argue that the government would need to borrow money to pay off its debts – just like individuals and businesses. Recall that one of the important roles of the Treasury is to issue money. This involves printing physical money or cash. But, more significantly, in the modern banking system, issuing money means debiting certain accounts and crediting others – which is all done digitally.
That the government need not rely on taxes or borrowing to pay for its debts is one of the arguments of Modern Monetary Theory (MMT) – an economic theory that promotes a new way of thinking about governments with fiat currencies.
Professor Yeva Nersisyan, who teaches Money and Banking at F&M, summarizes below the MMT perspective on the debt ceiling:
From the MMT perspective, a debt ceiling makes zero sense for a government with its sovereign currency, such as the United States. We technically don’t have to issue bonds to be able to spend. We can spend by creating central bank liabilities, reserves, and leave them in the system. Bonds simply withdraw those reserves from the system, but there is no reason why that should be done. Issuing bonds is a leftover from an era when we didn’t have a sovereign currency. And the debt ceiling is a leftover from such an era as well. It was instituted in a time when first, we were on and off some kind of a gold standard. So, it was important to limit government spending to maintain convertibility to gold. And second, we didn’t have the kind of federal government we had today. Before the Great Depression, the federal government was 2% of GDP. Today it’s 20%. Further, when the debt ceiling was instituted, we didn’t have regular sales of government bonds and an established bond market. Bonds were issued on an as needed basis to pay for a war, etc. That’s because we didn’t have a federal government that was a significant economic player. Things are different today and for a good reason (recall your Keynesian economics!).
So, the responsible thing to do will be to abolish the debt ceiling altogether. It serves no useful purpose in a country with sovereign currency. Congress already has the tools to limit government spending (or increase it) if it wants to (we don’t need a debt ceiling; we have a budgeting process in place already!). If, for example, there are enough votes to cut social security, then Congress can cut social security. We don’t need a debt ceiling for that. What the debt ceiling then does is forces Congress to cut social security, for instance, even if it doesn’t want to. So what we are saying is that today’s Congress is forced to do something it doesn’t want to do because Congress a long time ago did something, like institute a debt ceiling. This is clearly undemocratic. Congress has voted for the budgets, it has appropriated the spending, it can’t now refuse to pay the bills.
Indeed, instances where Congress has deliberated a budget but later fails to pay the bills due to a debt ceiling are not uncommon and such cases are damaging to the U.S. economy and the public’s trust in the system.
What should lawmakers do about the debt ceiling? For now, the options seem limited to suspending or raising the ceiling. However, long-term stability would require a permanent solution, whether that is to abolish the debt ceiling or come up with a better alternative to the century old legislation.
Learn more here.
Senior Robel Tadesse is a contributing writer. His email is rtadesse@fandm.edu.