Senators in Washington passed a deal Thursday to temporarily raise the country’s debt limit, giving the U.S. Treasury Department the ability to borrow enough money for the country to keep paying its bills through the beginning of December.
The lack of agreement on the debt ceiling had been making both the Washington establishment and the financial markets nervous, as the country moved toward a crisis on Oct. 18, the day that Treasury Secretary Janet Yellen had warned the country might begin to struggle to pay its bills.
Debt ceiling crises have become a fairly regular feature of politics in Washington, but one that must seem strange — and even irrational — to people outside the U.S. Why does a rich and powerful country like the United States so frequently find itself on the brink of a fiscal disaster?
What follows is a brief explainer on the debt ceiling.
What, exactly, is the debt ceiling?
The United States government regularly spends more money than it takes in from taxes, fees, and other sources of revenue. That means that the country must regularly borrow money to make up the difference. The current accumulated federal debt stands at $28.4 trillion, according to the Treasury Department.
The responsibility for borrowing money falls on the Treasury, which does it by issuing different forms of debt instruments. These range from Treasury bills, that can mature in as little as a few days, to bonds that mature over 30 years.
However, the government places a cap on the total amount of debt that the Treasury can issue. The U.S. is unique among major economies in putting this restriction on the Treasury.
The existence of a debt ceiling means that Congress can pass spending laws that effectively require the Treasury to borrow money but can simultaneously withhold the authority to issue that debt by refusing to raise the statutory cap on borrowing.
Why does the U.S. have a debt ceiling in the first place?
Ironically, the debt ceiling was originally created as a mechanism that made it easier, not harder, for the Treasury to borrow money.
For the first 140 years of U.S. history, the Treasury was obliged to seek the permission of Congress every time it wanted to issue new debt. However, in 1917, when the U.S. government needed to borrow money to fund its participation in the first World War, this process became cumbersome.
Rather than demand that the Treasury seek permission for every war bond issuance, Congress gave the department blanket permission to borrow money up to a certain amount. Lawmakers would only need to get involved when and if that limit needed to be breached. After several changes to the rules over the next 20 years, a general limit was placed on all federal debt in 1939.
Raising the debt limit was treated as a routine matter for decades, but beginning in the first years of the 21st century, the issue became more politicized. Since then, the party opposed to the sitting president has often used it as convenient leverage for achieving policy concessions from the incumbent administration.
Why is raising the debt ceiling such a big deal?
The reason why potential U.S. debt defaults get so much attention is because of the disastrous effects such an interruption in payments would have, both domestically and around the world.
Domestically, default would impair the government’s ability to deliver basic services and to make payments to individual citizens and to the many contractors that do business with government entities.
In financial markets, U.S. Treasury securities are considered the closest thing there is to a risk-free asset. Any number of financial instruments and transactions are indexed to the interest rate the federal government pays on its borrowings.
If the ability of the U.S. to continue servicing its debts were compromised, it could cause a chain reaction that would drive up borrowing costs for everyone. The stock market would likely dive, impacting the retirement savings of millions of Americans. Additionally, the value of the dollar would erode, reducing the purchasing power not just of Americans, but of many people outside the U.S. who hold dollars as a reliable store of value.
Where is the disagreement?
Leaders of both political parties in the U.S. have said from the beginning of the current debt ceiling crisis that the borrowing limit must be raised, and that there can be no possibility of allowing a debt default.
However, Republicans in Congress have said that they will not provide any votes to raise the limit — not even for a preliminary vote that would allow Democrats to pass a debt ceiling increase all by themselves. They are insisting that the Democrats use an arcane legislative procedure known as “budget reconciliation” that can be brought to a vote with no Republican support.
Democrats are objecting to Republican demands, arguing that the need to raise the debt limit stems from spending commitments made in the past by both political parties, and that both parties should therefore share the responsibility of raising the limit.
Part of Republicans’ reason for demanding that Democrats use the reconciliation process is that it will require Democrats to set a fixed limit on the debt, thereby giving Republican politicians a massive number that they can use to hammer Democrats during the 2022 election season. Democrats would prefer to simply “suspend” enforcement of the debt ceiling, which would allow the amount of the country’s borrowing to increase with no fixed limit.
What happens next?
The deal that lawmakers announced Thursday would raise the debt limit by $480 billion, which is expected to cover the Treasury’s needs through about Dec. 3. It is unclear, however, when the country would again come close to defaulting. The Treasury has a number of tools it can deploy to postpone default, so the next deadline may be later than Dec. 3.
The deal does nothing to bridge the divide between the two parties on the broader issue, though, and makes it likely that in roughly six weeks, the country will again be counting the days until a catastrophic default.
Only this time, the stakes will be even higher. Dec. 3 is the same day that the federal government will be forced into a partial shutdown unless Congress can agree on a budget deal that will authorize the government to continue spending money.