The US Debt Ceiling Explained: How Did America Reach Here?

“Show me the money!” These iconic words, uttered by Jerry Maguire in the 1996 film, encapsulate the high-stakes debt ceiling in the United States. The repercussions are as gripping as any Tom Cruise blockbuster film.

The debt ceiling is the financial limit imposed on the United States government, just like a credit card has a predetermined credit limit. The government borrows the money when it has to pay the debt it owes

As of January 2023, the limit stands at $31.4 trillion. (Source: The Guardian). According to CFR, the government’s deficit has been nearly $1 trillion every year, since 2001.

While the country has never officially defaulted on its payments before, it may do so if the debt limit is not raised this time. Treasury Secretary Janet Yellen has set June 1 as the ‘hard deadline’ to raise the debt ceiling. Otherwise, the government may struggle to pay its bills post-June 15. (Source: CNN)

As America navigates the treacherous waters of fiscal uncertainty in 2023’s debt ceiling saga, we delve into the roots of America’s debt crisis and look at the past approaches to overcome this. In addition, we provide tips on how an average citizen can navigate this impending storm.

The Debt Ceiling Explained: How Did America Reach Here?

In 1917, Congress set its first debt ceiling or limit at $11.5 billion. President Woodrow Wilson passed the Second Liberty Bond Act of 1917 to increase borrowing amounts in the wake of World War I. 

The purpose of the debt ceiling was clear then. It would serve as a check and balance to control the government’s borrowing power. It comes into play when a budget deficit occurs (expenditure exceeds revenue received from tax). In such cases, the government borrows money by issuing Treasury bonds and other forms of debt to pay for services like social security, medicare and the military.

Since the debt ceiling allows the government to meet its financial obligations and fund its operations, a failure can push the country into a financial crisis or recession. It would have a negative impact on the economy, financial markets, and the country’s credit rating. It can also create uncertainty, affecting investor confidence.

To raise the debt ceiling, the government needs approval from Congress. It becomes a matter of political negotiation and can sometimes be a contentious process, with debates and discussions among lawmakers about the size of the debt, spending priorities, and the overall financial health of the country.

This means the government can’t borrow more money unless the limit is raised. Think of it as reaching the maximum limit on your credit card—you can’t make any more purchases until you pay off some of the existing balance or get a higher credit limit.

Looking back at America’s history, the debt limit has been raised 102 times since World War II. However, the real challenges first appeared in 1985.

1985: The Treasury adopts ‘extraordinary measures’ like temporarily “disinvesting” accounts like the retirement fund for federal employees and the Social Security trust funds. The debt limit raised to $3 trillion from less than $1 trillion.

1997: The debt limit is increased to nearly $6 trillion as part of the Balanced Budget Act of 1997. The limit is not raised for several years post this due to budget surpluses. 

2002: The US hits the debt limit and is raised to $6.4 trillion.

2011: A new chapter is written on the debt ceiling under President Barack Obama’s term and the deadlock with congressional Republicans. The limit
is raised under the Budget Control Act of 2011, two days before the Treasury estimates it will run out of money. However, the brinkmanship triggers the most volatile week for U.S. stocks since 2008. 

2013: President Obama suspends the debt limit until Feb. 7, 2014, and later reinstates it at $17.2 trillion. This is the first time in the debt ceiling’s history that temporary suspension was chosen over a specified numerical increase in the limit.

2017: A few weeks from the Treasury’s deadline (September) for Congress to act on the debt limit, President Donald Trump suspends it until December 8, 2017, following its reinstation at $20.5 trillion.

2019: President Trump suspends the debt limit for two years under the Bipartisan Budget Act, 2019.

2021: On October 14, 2021, just weeks before X Date, President Biden increases the debt limit by $480 billion to approximately $28.9 trillion. The Treasury Department projected that this will extend the default date by a few months before another debt limit shows up.

2021: In December comes another X Date. Just a few weeks before that President Biden raises the debt limit to $31.4 trillion. This allows the government to meet its financial obligations till the second quarter of 2023.

2023: The government hits the debt limit and deploys extraordinary measures. 

So, How Did The US Tackle the Debt Ceiling Crisis in the Past?

In each instance, the United States has faced a debt ceiling and debt crisis with a combination of legislative action and fiscal measures. These situations have required the collective efforts of policymakers, lawmakers, and other key stakeholders to find solutions that ensure the country’s financial stability and avoid default.

One such instance occurred in 1985 when the Gramm-Rudman-Hollings Act was enacted in response to a debt ceiling crisis. This legislation aimed to gradually reduce the budget deficit by implementing automatic spending cuts (Social Security, Medicaid and other vital securities were exempted) Additionally, it temporarily raised the debt ceiling, providing the Treasury Department with the necessary flexibility to borrow funds and fulfil financial obligations.

Similar measures were implemented In the mid-1990s during President Bill Clinton’s Democratic administration. However, these efforts led to two government shutdowns. Eventually, the debt ceiling was suspended, enabling the Treasury Department to continue borrowing and meet financial obligations.

Another significant debt ceiling crisis arose in 2011, resulting in the enactment of the Budget Control Act. This legislation introduced spending caps and established a Supercommittee to identify additional deficit reduction measures. If the super committee faltered, the act imposed automatic spending cuts called sequestration.

Another significant debt ceiling crisis arose in 2011, resulting in the enactment of the Budget Control Act. This legislation introduced spending caps and established a Supercommittee to identify additional deficit reduction measures. If the super committee faltered, the act imposed automatic spending cuts called sequestration.

Most recently, in 2019, the debt ceiling was suspended for two years through the Bipartisan Budget Act 2019. It raised the military and domestic programs budget to allow an additional $322 billion.

What Happens If the US Defaults in 2023: 10 Points

“Failure to meet the government’s obligations would cause irreparable harm to the U.S. economy, the livelihoods of all Americans and global financial stability,” Treasury Secretary Yellen wrote to Congress in January 2023.

1) Recession: If the default lasts more than three months, it could lead to a significant recession, potentially resulting in up to 8 million job losses. (Source: The Guardian). The US is likely to hit a recession in the third quarter, according to The White House.

2) Stock market collapse: The stock market, where many small business owners and individuals invest their savings, could collapse. The undercurrents can be felt as Wall Street stocks experienced a significant decline on 24th May. Dow Jones Industrial Average closed 0.69% lower, the S&P 500 saw a decline of 1.12%, and the Nasdaq Composite was the hardest hit with a drop of 1.26%. The stock market will plummet 45%, affecting retirement accounts.

3) Volatility in global markets: Defaulting on debt would create massive volatility across equity, debt, and other markets, with unpredictable consequences. The European Markets opened sharply lower and the UK below the 10 per cent inflation mark for the first time since August.

4) Spread of market dysfunction: Treasury market dysfunction could quickly spread to derivative, mortgage, and commodity markets, as investors question the validity of Treasuries used as collateral for trades and loans. According to a report by Zillow senior economist Jeff Tucker, the 30-year mortgage rate is predicted to surge above 8%, reaching its highest point since the early 2000s. Tucker projected a 23% decrease in the sales of existing homes, resulting in a seasonally adjusted annualized rate of 3.3 million in September.

5) Spike in interest rates: Even a short breach of the debt limit could cause interest rates to spike, impacting borrowing costs for individuals and businesses.

6) Freezing of short-term funding markets: Short-term funding markets could freeze up, further disrupting the flow of capital.

7) Wall Street selloff: A default would likely trigger a significant selloff on Wall Street, with UBS estimating the S&P 500 could fall by at least 20%.

8) Weakening of the U.S. dollar: Default would weaken the U.S. dollar, which plays a critical role in the global economy as the most important currency.

9) Suspension of social insurance payments and federal salaries: Failure to lift the debt ceiling could lead to the suspension of social insurance payments and salaries of federal and military employees.

10) Global economic repercussions: Defaulting on debt threatens to wreak havoc on the global economy, affecting prices and mortgage rates in other countries.

How You Can Prepare to Deal with the Debt Crisis?

Start by taking a close look at your finances, including your income, expenses, and savings. Identify areas where you can reduce spending and prioritize essential expenses.

Once you know your essential expenditure, figure out an amount you can save as an emergency fund to provide a safety net during uncertain times. Aim to save at least three to six months’ worth of living expenses to help weather any financial challenges.

Reduce and manage your debt as much as possible. Focus on paying down high-interest debt first, such as credit card balances. Consider exploring debt consolidation or refinancing options to lower interest rates.

In addition to this, be cautious with your use of credit. Avoid taking on unnecessary debt and be mindful of your credit card usage. Focus on responsible spending and timely bill payments to maintain a good credit score.

If you have investments, diversify your portfolio to reduce risk. A well-balanced investment strategy can help protect against potential market volatility caused by the debt ceiling crisis.

While it may be tempting to pause or reduce savings during uncertain times, try to maintain or even increase contributions to retirement accounts. Long-term financial planning remains important, even during a crisis.

Consult with a financial advisor who can provide personalized guidance based on your specific circumstances. They can help you navigate the crisis and make sound financial decisions aligned with your goals.

Explore opportunities to increase your income through side jobs, freelancing, or leveraging your skills. Supplementing your primary income can provide added stability during financial uncertainties. You can also take advantage of government assistance programs that may be available during a crisis. 

The consequences of a debt default could be far-reaching, affecting job security, stock market stability, and global financial markets. Individuals must be prepared for the potential fallout from a debt default. Assessing personal finances, reducing debt, and creating an emergency fund can provide a safety net during uncertain times. 

We, at Vola, remain committed to supporting individuals in navigating the potential challenges posed by the debt ceiling crisis. We encourage you to download the Vola App to ease financial management. 

Did you Know? 

America has been debt-free only once, in January 1835. President Andrew Jackson’s administration achieved a remarkable milestone: the complete repayment of the United States debt to the Treasury Department. President Jackson, harbouring distrust in the paper currency issued by the department, liquidated the Second Bank of the United States, resulting in a surplus of $17.9 million in government funds.

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