The current debt ceiling—at $33.4 trillion—is expected to be reached around June 1. Once the ceiling is reached, the Treasury has a few gimmicks that it can use, such as delaying payments to the pension fund for federal employees, to postpone hard choices regarding which claims on the Treasury are to be paid. However, once those subterfuges have been exhausted, the Administration will need to decide whether to skip payments on the federal debt—default—or skip payments to other claimants, including federal employees, the military, social security recipients, contractors, or others. The Administration likely has a plan for which claimants will get paid and which will not be paid but is holding that plan close to the vest to avoid alienating any of these groups.
The consequences of defaulting on the debt get a lot of attention in the media and are very sobering. The United States has not defaulted on its more than two and one-quarter century history. Indeed, the first Secretary of the Treasury, Alexander Hamilton, wanted the new nation to have a gold-plated reputation for paying its debts so that it could borrow large amounts on favorable terms whenever necessary, especially when the fate of the nation was threatened by war. The United States signaled to creditors that it was determined to meet its obligations early on by redeeming at par defaulted obligations of some former colonies (now states of the Union). These obligations had been issued by those colonies during the Revolutionary War to fund their war effort. Hamilton’s scheme was highly successful and has served the United States very well for centuries, enabling the U.S. Treasury to borrow massive amounts at low interest rates. A good recent example is the COVID period: From early 2020 to early 2021, the Treasury borrowed nearly $5 trillion at extremely low interest rates.
Default would change the Treasury’s access to credit markets drastically, at a time when the Treasury will be needing to borrow increasing amounts over coming decades to cover a widening gap between federal spending and tax receipts. In the event of default, the Treasury would have to pay higher interest rates—perhaps substantially higher rates—as investors would insist on compensation for the credit risk that they would be absorbing. Moreover, the amounts that the Treasury would be able to borrow in the marketplace would not be nearly as plentiful. As a consequence, the Administration is likely to use its discretion to avoid default for as long as it can. This preference for servicing its debt would shift the burden to other claimants who can be expected to be highly demonstrative in their complaints. How long the Administration would defer other payments to avoid defaulting on the debt is unclear. In any event, the uncertainty that would accompany a period when the Treasury is unable to borrow likely would lead to turbulence in financial markets which could have adverse consequences for the economy.
The current outlook of an ever-widening deficit over the coming decades means that federal debt will continue to rise in relation to GDP, and debt ceiling confrontations will be an ongoing fixture of political life in the United States. Moreover, interest payments on federal debt will become a greater and greater claim on the federal budget, intensifying the squeeze on entitlements, defense spending, and other types of spending. This outlook is unsustainable, and, unless decisive action is taken to get control of the federal budget, it seems default is at some point all but inevitable.
In light of the disruptions that occur each time the debt ceiling is approached, does it make sense to continue with the debt ceiling? Doesn’t Congress already know what the implications of the budget it is formulating are for the amount of debt outstanding? Doesn’t the debt limit encourage counterproductive game-playing on the part of some Members of Congress?
To place the debt limit in perspective, the Constitution gives responsibility to Congress to “Borrow Money on the credit of the United States” (Article 1, Section 8). For the first century and one-quarter of our nation, Congress complied with this provision by approving each individual borrowing by the Treasury. However, in 1917, in the context of the need to borrow frequently and in large amounts to finance our participation in World War I, Congress established the debt limit. The debt limit was modified in the 1930s to become what it is today.
Over this time, Congress has been of the view that eliminating a debt limit altogether would violate the Constitution. Moreover, some Members see that by engaging in a game of chicken as the debt limit is approached to be a way to get certain legislation enacted that they cannot get enacted through the regular legislative process. Thus, it is unlikely that the debt ceiling will be removed as some are proposing.
Consequently, the onset of the debt ceiling constraint will continue to involve acts of brinksmanship as each side seeks to extract concessions from the opposition. During this process, each side will try to sway public opinion to support its position to strengthen leverage in the negotiations. To date, the parties to these confrontations have had the view that, in the end, default would have worse consequences than not getting all that they are seeking through the confrontation. And negotiators have agreed to concessions to avoid taking the conflict beyond the eleventh hour. This is likely how the current debt ceiling battle will play out. However, should the political arena become even more divisive and positions become even more hardened, the prospects for default will grow.