What is the Debt Ceiling, and Just How Close Are We to Hitting It?

The debt limit is poised to become the next battle between the White House and Congress ... the fiscal cliff deal reached by Congress only delayed the crisis for a few months. Currently the debt ceiling is $16.394 trillion, which is fast approaching ... likely sometime in late February. President Obama on Monday discussed the issue in his last press conference during his first term.

The debt ceiling’s history begins with Article I Section 8 of the Constitution: “The Congress shall have Power…[t]o borrow money on the credit of the United States.” Congress had to individually authorize each increase, until it changed with the Second Liberty Bond Act of 1917 that instituted a ceiling on U.S. Treasury bonds. This measure was introduced to help finance World War I.

The Public Debts Act of 1941 changed the debt ceiling once again to include all issuances of debt and aggregated all federal debt to the Treasury’s balance sheets. Since then no changes have been made to the debt ceiling — aside from increasing it. The Treasury is authorized to increase the government debt to pay the U.S. obligations signed into law by the appropriations process in Congress to the statutory limit set by the debt ceiling. Currently the debt ceiling is $16.394 trillion, which is fast approaching sometime in late February.

The debt ceiling for a very long time has been little more than a formality allowing the government to pay obligations it had already promised to pay through law. It was usually passed in conjunction with a budget. Only recently has it become a political tool to force spending cuts through halting increases in debt.

There are two major scenarios that can happen when countries either reach a statutory debt ceiling or a debt crisis (a country becomes unlikely of paying back its obligations and losses market confidence), either the country defaults on its debt, or it shuts down non-essential services. It is in general much better to go the austerity path than the default, but in some cases default and refinancing is the only option, (see Germany).

The first time that the debt limit was used to force government austerity was in 1995 and 1996. The Republicans twice refused to increase the debt ceiling and for a period of a little over a month the government stopped non-essential services to stop the country from defaulting on the debt.

It is difficult deciding which services are none-essential since there is little, if any, consensus on what is considered none-essential. If anything it shows how dependent many people have become on government agencies versus private institutions. In many countries, including our own, government shutdowns would lead to temporary chaos in industries that are heavily dominated by government agencies but long-term private companies have always risen up or returned to provide much needed services. With the fall of communism there was chaos in certain industries, and as the market returned the chaos disappeared.

The mounting U.S. debt is something that not just Americans but also our foreign debtors should be aware of its growth. The debt is quickly becoming problematic and could in the future lead to unavoidable default, hyperinflation, or both. The debt ceiling should not just be casually raised as a formality. There would be many better ways to reduce the debt without having messy government shutdowns but congress has proved itself unable of reducing spending in those ways. Not raising the debt ceiling could offer a situation where the U.S. could begin to face the hard reality, and wean itself off debt financing. Although, governments try to avoid shocks to the economy not all shocks are created equal, some shocks have good economic consequences. We should look at the debt ceiling for what it is: a limit that was set to prevent the U.S. from getting over- leveraged. A GDP to debt ratio of one-to-one is looking an awful lot like that.