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US Debt Ceiling

{analyse history of debt ceilings

impact of removal of gold standard

debt limit suspension 2014-2016 and 2018-2020 and 2023-2025

why USA keeps raising it?

other methods of raising government money





Introduction:


With another recent adjustment to the United States government debt ceiling, it becomes apparent that few issues spark as much debate as another rise in the limit. Due to the sheer size of the US economy, it operates under an entirely different level of scrutiny compared with the rest of the world, however, the congress seems to very frequently increase the maximum debt and avoid yet another default. This article explores the topic of the debt ceiling in more detail and aims to forecast what happens to the ceiling in the upcoming years.


The Construction of the Ceiling:


Created under the Second Liberty Bond Act in 1917, the debt ceiling set out a limit on the amount of debt that the US government can issue in bonds. If such a limit on the national debt is struck, the Treasury must switch its methods to other ways of raising revenue to fund expenditure. On the other hand, the debt limit is generally raised higher to free up more space for the government to issue bonds, rather than generating money through other pathways.


Throughout its existence, the statutory debt limit has been hit numerous times, with the latest being in January of 2023. Under the current regulations, the congress votes to either suspend or raise the ceiling. In the most recent case, the limit has been suspended until 2025, in order to not interfere with the upcoming presidential race in the US. In recent years, the congress authorised trillions of dollars added to the cap, leading it to almost tripling since 2009. The above fact has revived debates on the ceiling.


Concerns of Early 2023:


Having debated for months, the congress voted to suspend the limit yet again, thus bringing about a new discussion of whether the system is at all functional. If the debt ceiling is raised or suspended every time it is reached, critics see no reason for it to exist in the first place, as the limit is not enforced. Some lawmakers have also voiced their opinion on altering the limit to force the government into larger spending cuts. Overall, the debate has led to a fear of a government default, as it is no longer able to pay back on all the liabilities, which would lead to tremendous consequences for the US economy. Goldman Sachs projects that a breach of the debt limit would amount to a 10% halt in the economy.


To begin with, turmoils in the financial markets are a great concern. With the US government defaulting, the market volatilities are likely to rise, while the market prices of assets will see a drop. For example, the bond markets will see a fall. The default will cause a sharp decline in the market price of US Federal Reserve Bonds, due to the belief that they will no longer be paid out due to the government effectively running out of money. Thus, the bond market is likely to crumble, as the above bonds make up a significant proportion of it.


Furthermore, a default can have a detrimental effect on future government borrowing, as buyers of bonds in the future will see the purchase as being riskier, so interest and bond rates will have to be higher to compensate for that. In essence, the United States' credit safety will be questioned, and its effective credit score will fall, leading to sub-par borrowing conditions.


Last but not least, concerns arise from economic stagnation. A government default will bring about a drop in government expenditure, as well as a decrease in credit accessibility. Additionally, in the United States, a lot of the student loans are provided by the authorities, so the effect on economic growth can be long-term, as far fewer high school graduates will afford college degrees leading to a fall in the output of high-quality labour and enterprise. Altogether, the Aggregate Demand and Supply fill fall short due to the default, and will likely remain so through the years.


The Future:


Having looked at the potential consequences of a default, it is important to consider what happens next to the US government and economy. The default has seemingly been avoided, as the debt limit has been increased, however, the confidence of the public in the Congress and treasury has likely fallen. This will likely result in a short-term decrease in the value of bonds, although the issue is likely not to remain persistent in the upcoming months. Additionally, lowering confidence may lead to a large sale of US Treasury bonds in the secondary market, therefore depreciating the dollar.


It is also important to look at the US Dollar's position as the leading global reserve currency. With the US experiencing debt turmoil, the dollar's status may be affected, with the worldwide consensus being that it is too risky with the government being unable to manage its debts. This could cause a switch towards another currency, such as the Chinese Renminbi, which would sharply drop the value of the dollar.





Overall, the possibility of decreasing the dollar value is critical due to more than half of foreign currency reserves being stored in US dollars. Thus, a quake would go through the different world economies, likely leading to poorer countries also defaulting, causing a worldwide crisis.


Although, there could be an upside to the depreciation of the dollar. Many exporters across the states would benefit due to higher international price competitiveness of their goods, thus raising the total exports of goods and services. On the other hand, the same businesses would struggle from rising costs of imported raw materials and higher interest rates, so the outcome in terms of the value of exports is largely uncertain.


Possible Alternatives for the Department of Treasury:


In the case that the Treasury is unable to achieve an increase in the debt ceiling, there are numerous alternative measures that it may choose to take. Such actions are referred to as extraordinary measures and are only to be used in the most severe situations in attempts to avoid a full-scale default.


The Treasury may choose to halt salary payments to some government employees as well as cut down on transfer payments in various government programs. Although such measures have previously been used, the congress was always successful in achieving a rise or suspension of the debt ceiling, thus the measures listed above were never carried out to their fullest. If, however, the congress turned out to be unsuccessful, the government expenditure, in general, would have to decrease sharply, while the taxation would increase - an example of extreme contractionary fiscal policy.


What Happens After the Suspension:


Firstly, in 2025, there are two possible scenarios. Either the limit is reinstated, but at a higher value or it is suspended further. A suspension in the limit is largely unfavourable, as it may trigger a general dissatisfaction in the eyes of the public with the Department of Treasury. On the other hand, a raise in the ceiling is seen as a more advantageous strategy. It will open space for the government to borrow more to fund the expenditure, as well as being a measure that functioned well in the past. Overall, it is very likely that the ceiling will rise again once the suspension is lifted.


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