U.S. debt ceiling under scrutiny - Economics Student Society of Australia (ESSA)

“I have a more fundamental question. Why do we have a debt limit in the first place?”

More than two years have elapsed since former Chairman of the Federal Reserve, Alan Greenspan, expressed this sentiment – and it is still a question that begs answering.

U.S. Treasury Secretary, Jack Lew, has warned the United States Congress that the ‘extraordinary measures’ taken to temporarily increase its borrowing capacity after hitting its $16.7 trillion USD debt limit in May earlier this year will be exhausted no later than October 17 – mere weeks away. On this date, Treasury will have an estimated $30 billion USD on hand. While revenues such as taxation payments will continue to be collected, these revenues alone will be inadequate in meeting all of the Government’s obligations. Each passing day after October 17 exacerbates the risk of default. If an agreement is not reached in Congress and the Government defaults on its debt – the first time in U.S. history – there will be calamitous ramifications in financial markets worldwide.

Why does the U.S. have a debt ceiling?

Prior to 1917, Congress was forced to authorise each individual loan and debt issuance made by the Treasury. Individual approval proved to be a time consuming measure, and thus Congress began to loosen their grip on borrowing: by 1939 it concluded that Treasury should assume responsibility of involvement in borrowing. However, unwilling to concede full control to Treasury and also as a ‘safeguard’ measure to prevent it from borrowing a hypothetically unlimited amount, Congress implemented a debt ceiling – a limit on the aggregate amount of Treasury borrowing.

Since 1940, the debt ceiling has been increased 99 times by Congress. Every time debt levels have approached the limit, Congress has moved to raise the limit to ensure that the United States meets its financial obligations. This has played a vital role in solidifying the reputation of the United States as a risk-free safe haven for investors both domestically and around the globe. If history is anything to go by, Congress will increase the debt ceiling again prior to October 17, however with much hullaballoo from the minority party, the Republicans.

In ‘exchange’ for suspending the debt limit until the end of 2014, the Republicans have given a list of demands – that are more akin to threats – that they would like satisfied in return for their support. Included in the Republican’s exhaustive wish list, among other things, are demands such as: delaying the implementation of the controversial Affordable Care Act (more widely known as ‘Obamacare’) by one year, energy provisions and reforms (including giving the green light for environmentally detrimental projects such as construction of the Keystone XL pipeline and increased offshore drilling), and tax reform.

The Republicans have the notion that raising the debt ceiling, not defaulting on Government borrowing, and effectively not sending the global economy into a chaotic tailspin will benefit the Democrats and thus they must seek to get something in return. However the alternative, defaulting on Government debt, would have extensive catastrophic effects with no winners emerging. Global financial, stock, and bond markets will nosedive, consumer and business sentiment will plummet, and the U.S. economy could risk receding back into a recession. Even if Congress strikes an eleventh hour deal as it did back in 2011, the economy will still suffer. The Bipartisan Policy Center has estimated that the uncertainty and concern expressed by market participants over the potential breach of the debt ceiling in 2011 will cost nearly $19 billion USD over 10 years. In addition to this, the U.S. could face the risk of a credit downgrade.

The real leverage that the Republicans are utilising is the reputation and public opinion of the Obama administration. If Congress fails to increase the debt ceiling in a timely manner, Mr Obama will leave a legacy of not only being the first African-American President, but also the first in history to ‘allow’ the U.S. Government to default on its financial obligations.

Going forward from here

Ideally, Mr Obama should continue to refuse to use the debt ceiling as a bargaining chip by Republicans and push for a no-strings-attached increase. Threatening the Government of the United States’ credibility, the health of fragile financial markets around the world, and the livelihood of those dependent on Government payments – such as war veterans and those on social security – in order to further a failed agenda is a dangerous game with a detrimental outcome. Moreover, as the debt ceiling deal proposed by Republicans will expire at the end of 2014, Democrats will face a similar situation not only next year, but in subsequent years to come.

The debt ceiling was first established during an economic period that perhaps warranted the necessitation of it. However, as American politics and the economy have evolved and grown, the ceiling has become increasingly redundant. At present, the ceiling serves as little more than a bargaining chip used to push the Republican Party’s agenda – something that the people of the United States rejected at the polls late last year. Along with Denmark, the U.S. is one of only two nations to have a debt ceiling. Denmark’s handling of the ceiling has been more practical than political. They doubled their ceiling limit in 2010, when their debt levels were not even close to touching the limit, to insure against the very dilemma that America is tackling now.

In the long-term, the U.S. needs to seriously consider following in Denmark’s footsteps and drastically increasing their debt ceiling or better yet, scrapping it altogether. If the U.S. chooses the former, retainment of the ceiling would be largely symbolic. In a survey conducted by the University of Chicago’s Booth School of Business of 40 leading economic academics, 84% of those surveyed believed that ‘a debt ceiling that has to be increased periodically creates unneeded uncertainty and can potentially lead to worse financial outcomes’. Moreover, current Chairman of the Federal Reserve, Ben Bernanke, affirmed the view held by the leading economic academics by stating that he believes it ‘would be a good thing if [the US] didn’t have [a debt ceiling]’.

Without pursuing one of the aforementioned two alternatives, the U.S. will perpetually be stuck in this political predicament every time the debt ceiling approaches being breached after a previous marginal hike. In the short term, without a doubt the only logical and reasonable solution by Congress is to raise the ceiling. However, in the longer term, Congress must either eradicate the ceiling entirely, or increase the limit so significantly that exceeding the borrowing limit does not continually create financial and social uncertainty, and damper the recovery and growth of the United States.