If something keeps being raised, is it really a ceiling?
Written by our new senior editor, Benjamin Peters
Edited by Gabe Agüero
The debt ceiling has been in the news several times over the past few weeks, along with the looming deadline on Thursday to avoid a "federal debt default" But what does that really mean? How will you be affected if it does happen?
The federal government has, for many years, spent more money than it takes in via tax revenue. This leads to our 'national debt' - that is, the money the government has borrowed to pay off the budget deficits. You've probably heard about the national debt - the different political parties like to fight over it every election season - but for all the struggle and harsh words, it really is a stable arrangement. The US has had a national debt since 1790, and while it is a huge number, that often has not mattered too much.
However, there is one big problem with debt in general - that you have to pay it back. Previously, the US has been paying off its old debt by simply taking on more debt from other sources. People are willing to lend money to the government since they tend to pay more in return (this extra money is called interest). This is where the "debt ceiling" comes into play. In 1939 the federal government instituted a cap on the total amount the US can borrow at one time. Since then, the limit has been raised periodically in order to accommodate both increased spending and inflation.
Recently we have been rapidly approaching the limit, and in fact it was exceeded this July. The Treasury Department has essentially been running on fumes ever since, hoping that Congress would be willing to raise the limit so they can borrow more before they completely run out of money and have to default. Enter the current debate over the debt limit - the so-called X-date (the day the Treasury will be out of money) is October 18th, and the last day for Congress to pass a resolution to raise the limit is this Thursday, the 30th of September.
Now, back to the original question - what does it mean if the government defaults, and how will it affect you? A default simply means that the government cannot pay its bills and money borrowed previously cannot be repaid. For context, this has never occurred in all of American history, so we do not know for sure what will happen, but many economists predict a recession, albeit of unknown size. What we do know is that the US government debt has always been reliable, oftentimes considered as one of the safest places to invest money. Due to this low-risk nature, it has tended to have fairly low interest rates - .003% for a 3-month bond all the way up to 2% for a 30-year bond. Indeed, many other nations and financial institutions have tied their interest rates to the US Treasury due to its stability.
Should the US government default, the interest rates would likely go up quite a bit as the Treasury promises more money to bond-holders to make up for lost time (bonds have a set expiration date when their holder gets paid, but if they cannot be paid it will have to be delayed). This would have global implications, given that the strength of the US bonds is in large part due to the trust of countries around the world. While this may seem like a win for investors, it really is not, as the general uncertainty and other economic issues are predicted to produce a big dip in the stock market. Additionally, with this default, the reliability of the US government debt will be put into question, leading to it becoming harder for the government to raise the debt it needs to continue functioning. Most likely, investors will want higher interest rates to counteract the increased riskiness of the investment, meaning the federal debt will now significantly increase, making it even more difficult to stay under the debt ceiling. In the short term, it is estimated that up to $175bn will be withdrawn from the economy, while in the longer term it will significantly hurt economic and job growth.
How will it affect you? Probably not too much, unless you have a lot of money in the stock market. Even if you do, don’t panic! As history dictates, markets will always recover - and maybe there will even be an opportunity to buy while stocks are low. That being said, some estimate that the market could contract by up to one-third. On the other hand, if you get any sort of money from the government - whether that’s military pay, food assistance, veteran’s benefits or Social Security - you would not be paid until the government is allowed to raise money again. Most likely, though, when that does happen you will gain a bit of extra pay to make up for it, like what happens whenever the government shuts down.
Team, The Investopedia. “National Debt.” Investopedia, Investopedia, 27 July 2021, https://www.investopedia.com/updates/usa-national-debt/.
Rappeport, Alan. “The US Debt Ceiling: Everything you Need to Know”. New York Times, New York Times, 27 September 2021, https://www.nytimes.com/2021/09/27/us/politics/us-debt-ceiling.html
Gittleson, Kim. “What happens in a US debt default?” BBC, BCC, 17 October 2013, https://www.bbc.com/news/business-24453400
Ewall-Wice, Sarah. “What happens if Congress doesn’t raise the debt ceiling?”. CBS News, CBS News. 22 September 2021, https://www.cbsnews.com/news/debt-ceiling-limit-congress-united-states-economy/