The Constitution assigns Congress the task to authorize government borrowing necessary to pay for the financial obligations incurred by the United States. In the early 20th Century, the debt limit was instituted so that the Treasury would not need to ask Congress for permission each time it was necessary to issue debt to pay bills. The most recent debt limit or ceiling of $31.4 trillion was reached this past January 19th. Since that deadline, the Treasury Department has applied accounting maneuvers known as extraordinary measures to continue paying the government obligations and avoid a default. This measure temporarily curbs certain government investments so that current bills continue to be paid. It was believed that these steps would extend the time frame to raise the debt ceiling until well into the summer. Just recently, however, Treasury Secretary Janet Yellen sounded the alarm and suggested that June 1st could represent the deadline when immediate action would be required.
How did we get to this point? While the debt ceiling has generally been raised without objections over the years, there were two occasions in 2011 and 2013 when Congress delayed passage just prior to the deadline before approving the increase. Despite raising the limit before reaching the deadline, there were consequences. As a result of the impasse in 2011, the credit rating for U.S. Treasury bonds was downgraded thus increasing interest rates on government bonds and expense to taxpayers. The impact of an actual default this time around would likely be much more severe.
Many economists believe that economic and financial turmoil will ensue if the debt ceiling is not raised by June 1st. Dire scenarios have been predicted such as a stock market plunge, chaos in the smooth running Treasury market, a recession in the U.S. economy accompanied by a large spike in unemployment and ultimately the need for drastic steps by the Federal Reserve to stabilize the economy.
The main sticking point to an agreement is that Republicans led by their slight majority in the House are demanding a reduction in government spending as a condition to raise the debt ceiling. Biden and the Democrats are insisting that they will not decrease spending and claim that the Republicans would implement spending cuts that include reducing entitlements, particularly Social Security and Medicare.
I believe that an agreement will be reached before the deadline. In order for this to happen, both parties will need to declare victory. My best guess is that any agreement that reduces spending will be framed as freezing previously approved spending increases rather than actual reductions. From a political perspective, failure to reach an agreement can hurt both parties. Since raising the debt ceiling is necessary to pay past bills not future spending, and debts skyrocketed during the Trump Administration, many voters may blame the Republicans. On the other hand, Democrats may be perceived as out of control spenders as a result of the passage of the massive infrastructure bill during the last session of Congress. It has been suggested that if an agreement is not reached and in order to continue to pay bills, President Biden will cite the 14th Amendment as justification for raising the ceiling. This Amendment clearly states that the public debt of the United States shall not be questioned. If Biden were to take this step, it would likely be challenged in court but would effectively buy time and extend the deadline.
Unfortunately, the lack of bipartisanship continues to hinder legislative progress that can advance the American agenda. However, I remain optimistic. As Winston Churchill once observed about the United States, Americans will always do the right thing after they have tried everything else.
As usual, I welcome your comments and/or questions.
Sincerely,
Clifford L. Caplan, CFP®, AIF®