For those of you who follow the news, you’ve probably seen the phrase “debt ceiling” in the headlines these past few weeks. But how many people actually know what it means?
Normally it’s just a formality, and Congress increases debt ceiling as a matter of course without much publicity. However, the current political climate has changed the system, and, unfortunately, the debt-ceiling proceedings have become very important. Most media discussions taking place wrongly assume that everyone already knows what it is.
So, here’s a quick outline of how it works.
When the United States borrows money, it usually does so by issuing bonds. A bond is essentially a piece of paper that promises that in exchange for cash now, the U.S. government will pay back the face value of the bond in a certain period of time. And up until that end date, they will pay out interest on the face value every year. Essentially, it’s a loan to the U.S. government by the people who buy the bonds. When the Treasury issues these bonds, selling them to raise cash today, we say that they have issued debt.
The United States, unlike most other developed, democratic countries, has a debt ceiling controlled by the legislature. The Treasury is allowed to issue bonds until they have reached a certain amount of debt — the debt ceiling. Then, Congress has to pass legislation raising the debt ceiling so that the Treasury can issue more to raise more cash and pay the country’s bills.
Let us be clear: The debt ceiling is not about spending. Saying that we shouldn’t raise the debt ceiling because we need to be spending less is like saying you won’t pay your electricity bill at the end of the month because you’re trying to cut back on spending. You already spent the money when you were using electricity all month and now you’re just paying the bill for it. And if you don’t, you may find yourself having a hard time getting electricity in the future.
Right now, U.S. Treasury bonds are considered risk-free investments, because the United States has always paid its bills. This distinction means the nation get to borrow at very low interest rates.
Although it hopefully won’t come to this, since Speaker John Boehner (R-Ohio) indicated that he will not allow a default, what would happen if Congress didn’t raise the debt ceiling?
If it isn’t raised, there won’t be enough cash on hand for the Treasury to pay all of its obligations. Any number of expenses could go unpaid, including paying back the debt on bonds that were issued in the past. A default on past debts, meaning the United States fails to pay back its loans on time, would mean that U.S. Treasury bonds are suddenly no longer risk-free, and the United States would have to pay higher interest rates to make up for it. This would mean that the deficit would go up as the United States pays more for every dollar it borrows.
There would also be adverse effects on the global economy. When something that has long been considered a sure, stable thing, such as U.S. bonds, is suddenly unreliable, there are sure to be shockwaves to the world economy. The Treasury released a statement last Thursday saying that failure to raise the debt ceiling “could have a catastrophic effect on not just financial markets but also on job creation, consumer spending and economic growth — with many private-sector analysts believing that it would lead to events of the magnitude of late 2008 or worse.”
Given the potential magnitude of the consequences for the United States and the global economy if Congress doesn’t raise the debt ceiling, it’s irresponsible for them to even consider it. It would accomplish nothing. It’s not a decision about spending, and the only effect it would have on the deficit would be to increase it by increasing interest rates. Even the possibility that Congress will fail to raise the debt ceiling is already harming the economy, according to some economists. And some experts have started investigating extraordinary measures President Barack Obama could take to raise it on his own, just in case.
It’s important that we all understand what’s going on with the debt ceiling and why it matters. The public needs to make sure Congress understands that the debt ceiling is not an opportunity for political posturing.
Lissa Kryska can be reached at lkkryska@umich.edu.