As the United States grapples with its national debt, the issue of the debt ceiling has emerged once again as a critical concern. Established during World War I in 1917, the debt ceiling imposes a limit on the amount of money the US Treasury can borrow to fund government operations and meet legal obligations such as Social Security, Medicare benefits, military spending, interest on the national debt, tax refunds, and other essential payments. In this blog post, we delve into the history, current challenges, and potential consequences associated with the US national debt ceiling and the debt itself.
A Historical Perspective
Originally designed to promote fiscal responsibility, the debt ceiling allowed the Treasury to issue bonds and assume debt without explicit Congressional approval, as long as the total debt remained below the statutory limit. In 1939, Congress consolidated the limits on different forms of debt into a single aggregate debt limit, granting the Treasury Department broad discretion in utilizing borrowing instruments. Since then, Congress has frequently adjusted the debt ceiling, with 78 separate actions taken to raise, extend, or redefine it. This includes 49 times under Republican presidents and 29 times under Democratic presidents.
The Current Situation
As of January 19, 2023, the federal debt reached its current limit of $31.38 trillion. Consequently, the Treasury Department has resorted to employing “extraordinary measures” to manage the nation’s cash flow and debt in order to avoid default. The prospect of default on the US debt is considered catastrophic, not only for the American economy but also for the global financial landscape. A US debt default can be catastrophic because it would erode investor confidence, trigger a severe financial crisis, lead to skyrocketing interest rates, destabilize markets, and potentially plunge the global economy into a recession.
However, historical evidence suggests that congressional leaders from both parties have always recognized the urgency of raising the debt ceiling and have consistently reached agreements to avert default. Even though likely, it remains to be seen whether the current situation will follow the same path.
The Growing National Debt
One notable difference between the present debt ceiling challenge and those of the past lies in the size of the national debt itself. Although experts may not yet agree on a definitive debt threshold, the risks and inevitable consequences of an ever-increasing debt burden are apparent. It includes the potential for higher interest rates, reduced private investment, crowding out of productive government spending, inflationary pressures, and a burden on future generations who will have to bear the costs of servicing the debt and potentially face reduced government services and benefits.
Analyzing the federal budget from 1901 to 2022, it becomes evident that the United States has run deficits 75% of the time and achieved surpluses only 25% of the time. The last surplus was recorded in 2001, meaning that the nation has operated with a deficit for the past 20 years, significantly contributing to the expansion of the national debt.
The Threat to Economic Durability
National debt has become a highly politicized and contentious topic, but there is no denying its potential threat to the nation’s economic resilience. A considerable portion of the federal budget is allocated to mandatory spending, including programs like social security, income security, Medicare, and Medicaid, which accounts for 63% of the total budget. Discretionary spending, covering areas such as defense and health and human services, comprises roughly 30% of the budget. Servicing the debt itself represents one of the government’s largest and fastest-growing expenses. Net interest payments on the national debt rose from $352 billion in 2021 to $475 billion in 2022, consuming 8% of the budget.
Understanding the Debt-to-GDP Ratio
While the United States holds the highest absolute debt among all countries, comparing debt sizes in dollars can be misleading. Economists consider the debt-to-GDP (gross domestic product) ratio as a better indicator of a country’s fiscal situation. This ratio reflects a country’s debt burden relative to its total economic output, providing insights into its ability to repay the debt. By this measure, Japan currently holds the highest debt-to-GDP ratio at 259%, while the United States ranks 11th with a ratio of 128%. It is important to recognize that debt enables funding for critical programs, including retirement and disability benefits, healthcare, economic security, education, infrastructure, and national defense, all of which may yield future payoffs in various forms. Nonetheless, most economists acknowledge the risks associated with high levels of debt.
Seeking Sustainable Solutions
Continuing the pattern of running deficits and repeatedly raising the debt ceiling is an unsustainable approach to managing a nation’s fiscal policy. Such a pattern leads to a growing debt burden, higher interest payments, reduced fiscal flexibility, and increased vulnerability to economic shocks. To ensure a stable and prosperous economic future, policymakers must enact prudent fiscal policies, foster bipartisan cooperation, and prioritize addressing the root causes of deficits and debt.
In conclusion, while the current challenges surrounding the US national debt ceiling may seem daunting, there is reason to believe that a resolution will be reached, as it has been in the past. Both parties have a history of engaging in intense negotiations and playing hardball until the eleventh hour. However, when faced with the potential catastrophic consequences of a debt default, the urgency to strike a deal becomes evident.
Thomas Nuzzi
Equity Trader
Disclosures:
This is provided for informational purposes only and should not be interpreted in any way as investment, tax, accounting, legal or regulatory advice. An investor must take into consideration his/her individual circumstances.
There is no guarantee investment strategies will be successful. Investing involves risks including possible loss of principal. There is always the risk that an investor may lose money. A long-term investment approach cannot guarantee a profit. All expressions of opinion are subject to change. This article is distributed for educational purposes, and it is not to be construed as an offer, solicitation, recommendation, or endorsement of any particular security, products, or services. Investors should talk to their wealth advisor prior to making any investment decision.
Sources:
U.S. Department of the Treasury. (n.d.). Debt Limit. Retrieved from https://home.treasury.gov/policy-issues/financial-markets-financial-institutions-and-fiscal-service/debt-limit#:~:text=The%20debt%20limit%20is%20the,tax%20refunds%2C%20and%20other%20payments.
USAFacts. (n.d.). What’s the History of Debt Ceiling Increases in the US? Retrieved from https://usafacts.org/articles/whats-the-history-of-debt-ceiling-increases-in-the-us/?utm_source=google&utm_medium=cpc&utm_campaign=ND-Economy&gclid=EAIaIQobChMI8Mm9sIL6_gIVuBWtBh3l4wGlEAAYASAAEgJ9QPD_BwE
Committee for a Responsible Federal Budget. (n.d.). Q&A: Everything You Should Know About the Debt Ceiling. Retrieved from https://www.crfb.org/papers/qa-everything-you-should-know-about-debt-ceiling#when
Library of Congress. (n.d.). Debt Limit: History and Recent Increases. Retrieved from https://crsreports.congress.gov/product/pdf/IF/IF10292
Visual Capitalist. (n.d.). $31.4 Trillion: Owed in 2023. Retrieved from https://www.visualcapitalist.com/cp/us-debt-31-4-trillion-owed-in-2023/
National Public Radio. (2023, March 23). What Is the Debt Ceiling? An Explanation. Retrieved from https://www.npr.org/2023/03/23/1163448930/what-is-the-debt-ceiling-explanation
Pew Research Center. (2023, February 14). Facts About the U.S. National Debt. Retrieved from https://www.pewresearch.org/short-reads/2023/02/14/facts-about-the-us-national-debt/#:~:text=Servicing%20the%20debt%20is%20one,Office%20of%20Management%20and%20Budget.
World Population Review. (n.d.). Countries by National Debt. Retrieved from https://worldpopulationreview.com/country-rankings/countries-by-national-debt
Peterson Foundation. (2023, February 1). Interest Costs on the National Debt Are on Track to Reach a Record High. Retrieved from https://www.pgpf.org/blog/2023/02/interest-costs-on-the-national-debt-are-on-track-to-reach-a-record-high#:~:text=Interest%20payments%20on%20the%20national,another%2035%20percent%20in%202023
