It’s a simple fact: Every year the United States government spends more money than it brings in revenue. To fund many national programs, the government borrows money by issuing Treasuries. In a given year, 40 to 50% of U.S. expenditures are made with borrowed money.
As we continue to borrow money without paying back the debt, the federal deficit continues to increase. To keep government debt from getting “out of control,” Congress has limited spending through a national debt ceiling. As our deficit reached this alarming maximum in early 2011, the debate raged on: Should we increase the debt ceiling or change our spending policies? With the passage of the latest debt ceiling agreement in August 2011, the government chose to raise the debt ceiling by $2.4 trillion while instituting federal spending cuts of roughly the same amount to be achieved within 10 years. But was this the right decision? What are the pros and cons of raising the debt ceiling, and will doing so solve the nation’s long-term debt problems?
Debt Ceiling Defined
Simply put, the debt ceiling is a cap on the amount of money that the U.S. government is allowed to owe. It includes both public and private debt.
Since 1917, Congress has agreed on a limit of how much debt the U.S. can owe without risking default, and legislators raise the limit when they feel we need to borrow more money to sustain the economy. The legislature has raised the debt ceiling 74 times in the past 50 years, and about ten times since 2001. At this point, many voters and leaders feel that it doesn’t even make sense to have a debt ceiling, since Congress has the option to raise it virtually any time.
In early 2011, the US reached its $14.3 trillion debt ceiling. After intense debate in which both political parties wrangled for position and attempted to use the issue as political leverage for the next presidential election, the US, in August 2011, once again chose to raise the debt ceiling by roughly $2.4 trillion while instituting moderate federal spending cut mandates.
Arguments for Raising the Debt Ceiling
Many economists are mortified by the US debt situation, but still advocate for raising the ceiling. They feel that a decision to not raise the debt ceiling could cause an economic catastrophe on both a domestic and international scale. Potential consequences that Congress would face in a scenario in which it chose not to raise the debt ceiling:
- Cuts to Nonessential Programs. Programs like the National Parks Service would be shut down because Congress wouldn’t have the money to pay them. This would not only lead to significant job loss, but also have an effect on the daily lives of US citizens and the activities in which they can partake.
- Government Shutdown and Sending Home Federal Employees. Washington would have to place nonessential government employees on leave, sending millions of federal workers home until the debt situation is resolved. This decision could lead to crippling effects on the ability for the government to continue running efficiently.
- Default on Existing Debt. The government starts out in deficit before it can even pay interest on current Treasuries or pay for the bonds as they reach maturity. That means that the U.S. has to borrow more money just to pay off existing debts, and without raising the ceiling, the government would default on most of its existing debt obligations. Some people have gone so far as to describe the U.S. economy as a giant Ponzi scheme, and if the instability were exposed, citizens and other governments would quickly lose faith in the U.S. government. China and many other nations holding our debt are already afraid that we’re about to default. A default would make lenders less likely to provide funds in the future, seriously damaging our trading position with the rest of the world and raising the likelihood of future credit rating cuts.
- Economic Repercussions. If the government’s cash flow got cut off, then Congress would have to either significantly raise taxes or slash the budget by an astronomical amount. These rash decisions would have a devastating effect on the economy. In addition to rising interest rates, we’d face a damaged stock market and higher unemployment, sending a shockwave of economic turmoil through the rest of the world.
Cautions about Raising the Debt Ceiling
These ramifications are so serious and certain that it is almost certain that Congress will always raise the debt ceiling when it reaches its maximum debt. Doing so seems essential to the survival of our country, but this short-term fix comes with long-term potential problems. Experts who are apprehensive about raising the ceiling have a variety of valid reasons, including:
- Responsibility. Increase in the debt ceiling will just tempt our government to continue borrowing money and spending beyond its means. It’s like a credit card company raising your limit when you’ve maxed out and consistently missed payments. The government will lose sight of the immediate and long-term problems that we are facing and continue to fail to address the deficit.
- Collapsing Dollar. Raising the debt ceiling devalues the dollar. Our currency becomes riskier and less stable as we become more likely to default on our existing debts. This declining value weakens our purchasing power and could cause the dollar to lose its position as the world reserve currency. Inflation has already increased substantially and the rising price of food and oil are starting to get out of control.
- Rising Cost of Debt. The U.S. is already having more trouble than ever finding investors to borrow our debt. Last year, the Federal Reserve only had to purchase 10% of available U.S. treasuries. Today, they are purchasing close to 70%. As interest rates have dropped to record lows (about a .25% for a one-year bill), investors don’t see any point in investing in them. With countries like China unloading their current holdings in U.S. treasuries, we’re starting to lose our market for foreign investors. Moreover, with the country at constant risk of default, Standard and Poor’s took a historical step in lowering the country’s AAA bond rating to AA+ on August 5, 2011. With such a drop, major companies and countries won’t buy our debt. And for those that continue to buy our debt, it will be at significantly higher interest rates, which will further exacerbate the debt issue.
- Sending a Message. Deciding not to raise the debt ceiling signals to the international community that we’re serious about controlling our situation. Providing that sign just might be the best move we can make. The rest of the world needs assurance that we are going to work at getting our spending under control. Rather that constantly digging into a deeper debt hole, a decision to maintain the current debt ceiling while focusing on making drastic cuts and structuring a healthier economy could have unparalleled positive effects on the world economy and our relationships with other countries.
The 2011 Debt Ceiling Decision
In the end, Congress continued the past patterns of our country and chose to raise the debt ceiling by a significant $2.4 trillion. While the US also instituted mandated federal spending cuts, the majority of people feel these cuts did not go far enough. In fact, Standard and Poor’s clearly felt the situation was not solved, as it chose to lower the country’s AAA rating to AA+ in early August 2011, which not only will raise the cost of debt for the country, but also lead to much political and economic unrest.
Ultimately, the two political parties need to come together on a compromise and decide which programs they need to cut, whether taxes should be increased, and what should be the debt ceiling goal. Without an amicable, effective resolution, the US economy will suffer significant short and long-term consequences.
Clearly, Washington needs to solve its debt situation. Though 2011 isn’t the first time that the topic has come up or sparked heated discussion, it is the most alarming situation we’ve faced.
As our country continues to get itself deeper into debt, we have to come to the conclusion that we are going to have to start changing the way we manage our economy. We cannot forever depend on short-term solutions that get us into deeper debt. Sooner or later, we will have to accept that we are going to have to change taxes, reduce spending, and start resolving our debt situation before we continue to borrow more money.
What do you think the US needs to do to solve the debt crisis? Do you agree with the past decisions to raise the debt ceiling?
(photo credit: Michael Martinez, Creators.com)