The debt ceiling melodrama

US federal debt has its limits. Richard Vague tells the tale.

One of the great melodramas of American politics erupts in Washington when the federal debt approaches its statutory limit and brings the threat of a government shutdown and financial crisis unless the Congress and the President raise that limit. The next such shutdown is possible this summer. In a shutdown, federal agencies must cease all discretionary functions until new funding legislation is passed, and the Treasury is limited in issuing new debt. Essential services continue to function, as do mandatory spending programmes. 

There’s no chance in any foreseeable future that the Federal government will truly default on its debt, and no chance that it would ever lack the resources to service that debt.

This threat recurs chronically even though there’s no chance in any foreseeable future that the Federal government will truly default on its debt, and no chance that it would ever lack the resources to service that debt. This is true for a number of reasons: the government can issue currency, the Federal Reserve can buy Treasury debt, and, most importantly, government spending itself supplies the economy with sufficient funds to buy any debt it issues.  

So make no mistake: the debt ceiling is a piece of political theatre, most likely to get staged when one of the two legislative chambers is controlled by the party in opposition to the President. It’s an ideal script by which to proclaim the fiscal irresponsibility of the President and his party and provides momentary leverage by holding the debt ceiling hostage until certain budget demands are met and cuts made.  

The US is one of only two countries that have a debt ceiling set at an absolute amount rather than a percentage of GDP, which creates the bizarre situation of preventing spending that’s already legislatively enacted and authorised.  

In a shutdown — which can come from a budget impasse as well — ordinary people get hurt. Hundreds of thousands of federal workers risk being furloughed, as seen in the government shutdown of 2019, which resulted in the tragedy and embarrassment of federal workers standing in line waiting for food handouts. Also hurt are businesses that depend on government payments.

Even when a shutdown is threatened, it rarely occurs.

Manoeuvring over a debt ceiling can also roil financial markets, as in 2011, when it brought a downgrade of US debt by bond rating agencies and one of the worst falls in US stock markets in history — though these markets quickly recovered when an agreement was reached. 

The US has raised its debt ceiling in some form at least 90 times over the past century, and typically with little mention. Even when a shutdown is threatened, it rarely occurs. Only four shutdowns have occurred that lasted more than one business day, and they weren’t strictly related to a debt ceiling. The first two happened in the winter of 1995-1996 when, under President Clinton, an impasse on spending levels shut the government down twice for a total of 26 days. The third was in 2013, a 16-day shutdown provoked by a standoff over the Affordable Care Act. The fourth was caused by a dispute over border- wall funding in December 2018 and January 2019, and lasted 35 days, though it was technically only a partial shutdown.  

These don’t last long because the pressure to resolve the impasse — from both domestic and international sources — becomes so crushingly immense so quickly that a shutdown is simply unsustainable. The outcomes of these clashes have varied from productive to damaging. But as this summer’s potential debt- ceiling sequel approaches, it’s worth noting a couple of points. 

First, in the period since the pandemic-induced emergency recovery spending, government debt levels have been slightly improving, declining from 128% of GDP in December of 2020 to 120% in December of 2022.   

Second, and this is a point both more vital and more overlooked, government spending — even in periods when it’s viewed as excessive and profligate — mostly ends up in the pockets of US households. 

Let’s take 2020. In that year, during the darkest hours of the global pandemic, the US government spent $3tr to help rescue the country’s — and, to some extent, the world’s — economy. This infusion of cash increased US government debt and thus reduced US government wealth by almost the entirety of that frighteningly large amount — the largest drop in US government wealth since the nation’s founding. Surely something this unfavourable to the government’s “balance sheet” would have broad, adverse financial consequences to households?  

No. Household wealth rose during that same year. And it improved not just by the net $3tr injected into the economy by the government but by a whopping $14.5tr, the largest recorded increase in household wealth in history up to that point. Much of that $3tr went into household bank accounts and the large increase in debt pushed real estate and stock market values up another $11tr. 

In 2021, the story was similar. The government deficit was $2tr, but that net spending ended up mostly in the pockets of households, and real estate and stocks rose an even higher $16tr, such that total household net worth increased $18.8tr.

As this debt ceiling debate heats up over the next couple of months, tune into the debate, assuming there’s no better drama on Netflix.

In 2022, government spending continued, but the real estate and stock markets, which had been overheated, gave back some of their pandemic gains. Even with this, the increase in government debt of $8 tr in the three years of the pandemic era had brought with it an almost $25tr increase in household net worth. 

So, as this debt ceiling debate heats up over the next couple of months, tune into the debate, assuming there’s no better drama on Netflix. Be prepared to help out any furloughed neighbours if they get caught in the crossfire, but keep in mind that not only is the debt ceiling political drama, it’s a drama that gets the plot of the debt itself all wrong: large government deficits usually bring gains to US households.