Imagine living in a United States that could not pay its debts. Who do you think would suffer most
from this? The answer might surprise you. At first you may think, well, if the United States couldn’t
pay all of its bills, they would definitely take care of their citizens first. But are you
absolutely sure about that? Would the people in power be willing to lose billions of dollars just
to keep the average citizen happy? Deep down you probably aren’t so sure which bills the
United States government would prioritize to pay. Let’s take a look at what the U.S. debt limit is,
and what may happen if the government ever exceeds it. We’re warning you ahead of time,
the end result will not be pretty, and could change the world forever.
Simply explained, the debt limit, also called the debt ceiling, is how much money the government
is allowed to borrow to pay its bills. As the only current superpower in the world,
the United States has a lot of bills to pay each year. They cover things like Social Security,
Medicare benefits, military salaries, interest on the national debt, tax refunds,
and other payments. The reason that the United States government needs to borrow money from the
Treasury each year, is because the revenue coming in through taxes and investments,
is less than how much money the government owes to people both domestically and in foreign countries.
At this point you may be thinking, “well that’s weird. If I don’t have enough money
to pay my bills, I’m screwed, but somehow the United States government has not been able to
pay its bills for over 100 years and they seem to be doing fine.” You would be right
to be confused by this. As an individual, you can’t just decide each year to borrow
more and more money to pay for the bills that have accumulated. If you do try and do this,
you either go bankrupt or end up in jail. So, how does the United States government do it?
As of the last debt limit raise in 2019, the United States debt ceiling is just under
22 trillion dollars. It is important to make the distinction between the debt limit and the budget.
The budget is how much money the government plans to spend each year, while the debt limit is the
amount of money the government can borrow to pay bills that already exist. Raising the debt limit
does not increase government spending. Raising the budget on the other hand, absolutely does
increase government spending. You can think of the debt limit as borrowed money to make sure that the
United States government has the cash it needs to meet all of its financial obligations.
You might be wondering how this all started. When did the United States government decide it would
borrow more than it could pay back each year? The debt limit started in 1917 as the U.S. entered
World War I. The Treasury recommended a law that would allow the government to issue war bonds.
This would bring in more money to finance the war effort. The Treasury made it clear that only a
certain amount of bonds could be sold, since the government would eventually have to pay the bonds
back with interest. The very first debt limit for the United States was set at 11.5 billion
dollars. That is a lot less than the current debt limit, and we aren’t even in a World War.
It has never happened before, but let’s look at a hypothetical situation where the United
States government hits the debt ceiling and is unable to pay all of its bills.
At first things might seem okay, but they can go bad really quickly. You won’t believe
the lengths that the government will go to, to ensure they don’t reach the debt limit.
As the government gets closer and closer to the debt ceiling, the Treasury steps in to
enact what are called “extraordinary measures.” These decisions are used to slow the impending
financial crisis. One of the quickest ways for the government to get its hands on cash,
is to suspend daily reinvestment of government funds. As the federal government sets up funds,
such as for retirement plans, currency exchange, or government transactions, it invests a portion
of those funds in Treasury securities that mature. If done properly, the securities
create monetary interest for the funds. However, by reinvesting these securities on a daily basis,
the government does not have immediate access to any of the money tied up in securities.
Therefore, if extraordinary measures need to be taken, the government will stop reinvesting
and just use the cash from expired securities to pay off debt. This creates a pool of money that
is immediately available, but stops the growth of any fund that the securities are pulled from.
Think of it this way. You work for the federal government and have been paying into a retirement
plan. Everything is great, because your retirement fund is growing due to the investments by the
government. Then suddenly the government gets dangerously close to hitting the debt ceiling.
They start pulling investments from your retirement fund, and the growth of the fund begins
to slow, or even stops temporarily. The government will return the funds with interest when it can,
hopefully you weren’t planning to retire any time soon, otherwise you could lose a lot
of money. But hey, at least the federal government didn’t default on its debts.
There are other emergency measures that the government has in place
to mitigate reaching the debt limit. These include suspending pension funds,
pausing state and local government securities,
or borrowing money that is intentionally put aside to manage exchange rate fluctuations. None
of these are good options, but it’s better than what could happen if the debt limit is reached.
Now let’s imagine the unthinkable happens. The United States needs more money than it can
borrow. Things are about to get really scary, so you might want to prepare yourself. If the
debt limit is reached, it means the Treasury has run out of cash, and it cannot borrow any more.
Every day the Treasury collects money from taxes and loans owed to the government. It then uses
the money coming in to pay its own bills. If the government's bills exceed the money coming in, and
the government has no money left to borrow, the game is over. The government has to start deciding
which bills to pay, and which to push off until later. This is where things get really dicey.
Programs that are important to you like pensions, social services, and military veterans’ benefits,
might not be the same as what the government sees as important.
This could cause serious contention between the government and the citizens of the United
States. In fact, we guarantee that the government’s idea of what bills to pay,
would not be the same as the programs just mentioned. A released transcript from an
August 2011 Federal Open Market Committee meeting revealed something startling. The officials at
the Treasury and the Federal Reserve planned to prioritize interest payments on the federal debt,
over government programs if Congress did not raise the debt ceiling. This means that the
government would stop paying social services, to ensure there was enough money to make
interest payments to other countries and Treasury security holders. This seems a little messed up.
We are not arguing that those debts should not be paid. There would be huge negative
ramifications for not paying off debt with high interest rates, but is it worth defaulting on
obligations to the country’s citizens? Everyone will have their own opinion on the matter,
but it does make you think. The objective of the 2011 decisions was to make sure investors still
had some faith in Treasury bonds and securities. If the public lost faith in the Treasury, it would
make it much more difficult in the future for the government to find buyers to purchase securities.
This could lead to companies and corporations losing faith in the United States government,
and moving their operations elsewhere. All of these things together could lead
to an economic collapse, which inevitably would be bad for everyone around the world.
On top of these problems, if the debt ceiling was reached and people around the world started
to lose faith in the U.S. Treasury, then interest rates on all loans could go up. That would mean
car loans, credit cards, mortgages, and student loans would all increase their interest rates.
This snowball effect would lead to a recession, but more likely a depression reminiscent of the
1920’s and 30’s. Needless to say, it is vital that the United States does not reach its debt limit.
We can see the ramifications of the United States reaching its debt limit and not being
able to pay its bills, yet, raising the debt limit can be very controversial.
Why would something that could lead to economic collapse if not raised be
controversial? There is no way anyone could want the alternative… is there?
Over the years some legislators have argued that by refusing to raise the debt ceiling,
government spending would be reduced. This is unnerving for two reasons. Firstly,
because if the U.S. does not raise the debt ceiling it could lead to economic collapse.
Secondly, because the debt limit has no impact on government spending at all. As mentioned before,
government spending is determined by the federal budget, not the debt limit. Which makes us wonder
how competent these politicians are, if they don’t understand this basic difference between
the federal budget and debt limit. It’s a little frightening when you think about
it. These are the people making decisions for the most powerful country in the entire world.
Other politicians use the debt limit to their own advantage in a more devious way.
Their vote to raise the debt limit is sometimes used as a bargaining chip. These politicians
refuse to vote on the increase, unless their other demands are met. Most of the time this
has to do with reducing government spending through budget cuts, but politicians also may
refuse to sign on until they gain support for an unrelated bill. Politics are a nasty business.
Other politicians, as well as a number of former Treasury secretaries from both the Democrat and
Republican parties, believe that in order to keep up with the fluctuations of the world economy,
the debt limit should be raised every year. Others believe that there should be no limit to
the amount of money the United States government can borrow. Again, these people are not arguing
that the United States should be spending more money. They are arguing that the consequences
of reaching the debt limit, and not being able to pay the United States’ bills, is too much of
a risk to leave to cranky politicians with their own agendas. Instead, if there were no debt limit,
then there would be no chance of the United States defaulting on its monetary obligations. Government
spending can still be reduced through a well throughout budget, even if there is no debt limit.
It is important to note that as politicians debate passing debt limit increases, people in the United
States and around the world get nervous, and start dumping their Treasury securities. This
is exactly what the Treasury is trying to avoid, yet as politicians squabble, it happens anyways
due to the lack of confidence in the decision making process. This lack of confidence then
manifests itself in the stock market and other sectors, which in turn hurts the economy anyways.
So, should the debt limit be increased? Absolutely,
as long as the United States has bills to pay, it needs money from the Treasury. The
alternative where the United States is unable to pay its debt, is a scary scenario. However,
a different question is; should the United States continue to spend money at its current rate,
so that it needs to keep raising the debt limit? That is up for debate. There could be budget cuts
to parts of the government. Does the United States need to spend 732 billion dollars each year on
its military, which is more than the next top 10 military budgets from around the world combined?
Perhaps. Does the United States government need to give multi-million dollar companies tax breaks
that allow them to pay next to nothing to the federal government? Probably not.
It might be worth knowing where the politicians you vote for stand on raising the debt limit,
or at the very least which programs they want to fund. Either way, now you understand that the debt
limit is how much the United States government can borrow to pay all of its bills, and although
borrowing 22 trillion dollars seems like a lot, not having the ability to pay is so much worse.
Now check out What If The US Paid Off Its Debt? Or watch College Degrees That Earn The Most Money.