Mind the Ceiling: The Debt-Limit Drama

The U.S. debt ceiling places a limit on the total amount of money the federal government is legally authorized to borrow to meet its existing obligations, including Social Security and Medicare benefits, military salaries, interest on the national debt, tax refunds, and other payments. Once that ceiling is reached, Congress must decide to either increase the limit or suspend it altogether to cover the government’s bills.

Extending or suspending the debt limit does not authorize new spending. What lawmakers are being asked to do is enable the federal government to pay its bills on time and cover spending that Congress has already approved.

If the limit on the debt ceiling is not raised, the U.S. will default, producing what the Business Roundtable, an influential group of top executives, calls “an otherwise avoidable crisis [that poses an] unacceptable risk” to the country’s economy and markets. In an opinion piece in the Wall Street Journal, Treasury Secretary Janet Yellen said that default would result in “widespread economic catastrophe.” Without any action, it is expected that the U.S. won’t be able to pay its bills after Oct 18.

The debt limit, which requires both House and Senate approval to adjust, was first established by Congress in 1917. It has been raised and suspended over 100 times during the past 104 years by Congress regardless of party control, and under both Democratic and Republican administrations. Since 1970, the debt ceiling has been raised 78 times, including 49 times under Republican presidents and 29 times under Democratic presidents.

Still, yet again, there is drama in Washington over this process. It’s no spoiler to say that the limit, which is artificial, will be raised—because legislators have always raised or suspended it. The question is not whether the U.S. will default on its bills, but how much pain the partisan histrionics will inflict before the resolution. How close to the brink will we come?

Why does this predictable drama and its inevitable ending always return? Let’s look at the history channel.

Previously on the Debt Limit

Prior to establishing the debt ceiling, Congress was required to approve each issuance of debt in a separate piece of legislation, which proved cumbersome. To simplify the process and enhance borrowing flexibility, the debt ceiling was first put in place in 1917 through the Second Liberty Bond Act, which allowed the Treasury Department to issue bonds and take on other debt without specific Congressional approval. That ceiling set a limit at $11.5 billion.

With the United States Public Debt Act of 1939, Congress eliminated separate limits on different types of debt, creating the first aggregate limit covering nearly all government debt. The ceiling was set at $45 billion, about 10% above total debt at the time.

During the 1980s, the debt ceiling was increased from less than $1 trillion to nearly $3 trillion. Over the course of the 1990s, it doubled to nearly $6 trillion, and in the 2000s, it again doubled to over $12 trillion.

The Budget Control Act of 2011 automatically raised the debt ceiling by $900 billion and gave the president authority to increase the limit by an additional $1.2 trillion (for a total of $2.1 trillion) to $16.39 trillion. Lawmakers have suspended the debt limit seven times since February 2013 under both the Obama and Trump administrations. The most recent suspension began on August 2, 2019, under the Bipartisan Budget Act of 2019 and ended on July 31, 2021.

Debt and Deficit

The U.S. government spends much more money than it brings in through tax revenue, and that annual gap is known as the deficit. The Treasury Department borrows money to finance this deficit by issuing securities, known as debt, held by the public.

The Treasury Department can legally issue debt only up to the maximum limit set by Congress, even if Congress has approved a greater amount of spending, which is why the debt ceiling must be raised or suspended periodically.

Because government spending is projected to significantly exceed revenues this year and beyond, the government must increase the debt ceiling or default on its bills.

However, through emergency authority known as “extraordinary measures,” the Treasury Department can shift funds around and continue to pay its obligations on a temporary basis. The Treasury Department also owes money to other parts of the federal government. This is known as intragovernmental debt and is subject to the same ceiling limit.

In 2021, the government is expected to spend $5.8 trillion and bring in $3.5 trillion in revenue, leaving a deficit of $2.3 trillion, according to the Congressional Budget Office, which provides nonpartisan analysis for Congress.

The Treasury Department established “extraordinary measures” in August 2021 to conserve cash, but the agency is running out of options as autumn approaches.

In August 2019, the federal debt limit stood at $22 trillion when Congress enacted the bipartisan budget deal that suspended it for two years, allowing the government to borrow without a ceiling. On August 1, 2021, the debt limit was reinstated at approximately $28.4 trillion, a level covering all borrowing during the suspension.

The government is expected to pay $300 billion in interest on this debt in 2021, according to the Congressional Budget Office. Fueled by the passage of tax cuts in 2017 and a flood of spending in 2020 to counter COVID’s economic effects, the national debt ballooned by almost 40% to $28 trillion under the Trump administration.

What About Those “Extraordinary Measures?”

Once the debt limit was reached upon its August 1 reinstatement, the Treasury Department was forced, once again, to rely on “extraordinary measures” to make room for more public borrowing to continue paying pay the nation’s bills.

These “extraordinary measures” are, effectively, accounting maneuvers that involve artificially reducing certain intragovernmental debt, such as delaying contributions to the trust funds that hold federal employees’ retirement assets.

The Treasury Department has also announced actions such as suspending investments in employee health benefit funds to preserve its borrowing authority. The Congressional Budget Office has estimated that such “extraordinary measures” could claw back more than $340 billion in borrowing capacity under the limit. The budget office says these actions, combined with the Treasury’s current cash balance of about $356 billion at the end of August, would allow the government to avoid a payment default into mid-October.

The Treasury Department is required by law to make the funds whole once Congress approves a new borrowing limit.

The “X Date”

“Extraordinary measures” are distinctly limited, however, and only serve as a stop-gap procedure.

If the debt limit is not raised or suspended before these resources are exhausted, the Treasury Department will have to rely solely on daily revenues and residual cash on hand to keep meeting the nation’s obligations. With the federal government running a large budget deficit—especially after a year and a half of pandemic relief spending—these funds will deplete rapidly.

At that point—the “X Date”—the government will be unable to meet its obligations in full and on time. The Bipartisan Policy Center had projected that, absent congressional action, the X Date will arrive sometime before Thanksgiving. Janet Yellen further clarified this date as October 18.

The potential deadline had been more uncertain this year than in previous years because the pandemic has made it much more difficult to craft and model the government’s cash flows over the coming months. The deadline is highly dependent on when the remaining federal pandemic response spending disburses and whether the economic recovery continues to produce strong tax revenues. Federal spending has been much higher this year, and more predictable, as the government distributes pandemic aid such as emergency small business grants and state and local aid. Federal tax revenues were stronger than expected over the summer and economic activity picked up as more Americans were vaccinated, giving the government a bigger cash buffer.

Left unaddressed, the government would be forced to default on its obligations, which would trigger an economic calamity, as the Business Roundtable, Secretary Yellen, Moody’s Analytics, and many others have warned.

The federal government debt benefits from being perceived as the safest in the world, despite now exceeding 100% of GDP. A standoff that raises the specter of default could put that perception at risk. Secretary Yellen warned that lawmakers should not be “waiting until the last minute” to address the risk of “irreparable harm to the U.S. economy and the livelihoods of all Americans.”

However, lawmakers appear happy to wait until the last minute to raise the debt ceiling as they tussle over political leverage and electoral optics.

Conclusion: Tell Us When It’s Over

At Bowen Asset Management, we are confident the debt limit will be raised again. The only question is how it will get done once the politicians stop playing with fire, and who will get burned. But it will get done.

Markets have been sanguine thus far, as the limit has always been raised before serious economic harm is done. Treasury bills that mature in late October and early November are offering only minute concessions, signaling a minor shift to protect against the possibility of a missed payment.

Interest rates on long-term bonds are holding at low levels, and once the debt ceiling is raised, there is no question that the U.S. can afford to service its debt. In 2020, the U.S. spent nearly $500 billion on interest payments, representing about 15% of federal government revenue; this expenditure is lower than it was a decade ago. The national debt has trended upward for decades without triggering financial pressure.

Some new debt would not harm the nation, especially if it is spent on productive investments in physical and human capital. However, especially as social benefit costs rise, fiscal crowding will become a greater concern.

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