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The U.S. Debt Ceiling Explained
We all have budgets to keep; whether or not we can
comfortably keep them is a matter of planning for our
income and expenses.
The U.S. government, as large and far-reaching as it is,
has a budget of its own. Unfortunately, it is not always
possible for the government to fulfill all its legal
obligations with the money it receives. Each year the
government must find ways to fill any budget deficits.
The government does this by borrowing through public
or internal debt.
Because it is considered profitable and safe to own U.S.
bonds, the public has never declined to purchase them.
Therefore, the U.S. government must determine its own
limits for how much it can allow itself to borrow. This
amount, the debt ceiling, is set by a vote from Congress
and determines when the government legally must stop
increasing its debt.
The U.S. government cannot continue to borrow forever.
Much like a credit card company putting a limit on a
cardholder’s spending, the government has restrictions
for its debt —this is known as the U.S. debt ceiling.
Some national debt is not a bad thing, but ideally,
governments will only have significant deficits during
periods of war or economic downturn. When a country is
functioning normally, it should be producing moderate
budget surpluses to offset its debt and prevent it from
reaching its debt ceiling. (Because debt ceilings are fixed
amounts, they eventually must be raised to compensate
for inflation.)
How Does National Debt Work?
In terms of calculation, a country’s national debt works
like an individual’s debt. A country has income from
taxes (and other sources) and expenses from the
programs it runs and employees it pays. If the annual
expenses exceed the annual income, the government is
said to have a deficit.
Some national debt is not a bad thing, but
ideally, governments will only have
significant deficits during periods of war or
economic downturn.
When the U.S. government has a budget deficit, it has
the U.S. Treasury Department issues government bonds
to pay for it. These bonds are purchased by private
individuals or foreign government and guarantee the
holders a certain interest rate over the life of bond. This
means that every dollar the government gains through
selling bonds, it will eventually have to pay back more.
The money the government owes for these bonds is its
public debt.
Why Is the United States in Debt?
Except for a brief moment in 1835, the United States has
always been in debt. Wars have traditionally caused the
majority of the strains on debt —World War II being the
peak for debt as compared to the rest of the value of the
economy or gross domestic product (GDP). However,
because periods of rapid economic growth have always
followed wars, extra debt has always been paid off
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Management, Inc.. The information contained in this article is not intended to be tax, investment, or
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quickly while the reasonable portion of the debt kept
pace with changes in the economy.
Starting in the 1980s, though, the government debt
began to grow faster than the GDP. The Unites States
began a habit of overspending and the national debt
ballooned. In 2012, under the stress of a worldwide
recession, the public debt surpassed the nation’s GDP
for the first time since World War II. The U.S.
government officially owed out more than the country’s
economy is worth in a year. Presently, the total U.S. debt
sits at over $19 trillion.
With each increase in budget, the U.S. Congress has
had to adjust the debt ceiling. Since 1960, the
government has raised the debt ceiling more than 70
times.
spending money on its legal obligations. In essence, the
United States would default on its loans. This would
have horrific ramifications that would go far beyond a
simple government shutdown.
Why Not Default?
It is not an understatement to say that a U.S. default on
its debts would reshape the world economy as it
currently functions. The United States has, by a wide
margin, the largest economy and government budget in
the world. Moreover, the U.S. dollar and U.S. Treasury
bond are staples for secure purchasing and investing in
many countries. A sudden change in the reliability of
U.S. bonds (and a subsequent inflation of the dollar)
could push the world into a deep economic depression.
The U.S. Department of the Treasury has made the
following statement on increasing the debt limit to meet
its budget: “Failing to increase the debt limit would have
catastrophic economic consequences. It would cause
the government to default on its legal obligations—an
unprecedented event in American history. That would
precipitate another financial crisis and threaten the jobs
and savings of everyday Americans—putting the United
States right back in a deep economic hole, just as the
country is recovering from the recent recession.”
Paying Off the Debt
With massive debt unsustainable and a defaulting on
obligations not an option, the United States will have to
alter its budget enough to start receiving surpluses every
year. To make this transformation, the government can
either increase its income or lower its expenses (or
both). Unfortunately, neither or these options are always
viable.
Raising and Surpassing the Ceiling
Despite what many people think, the debt ceiling does
not determine how much the government spends, but
when it cannot issue more bonds. The U.S. budget, also
voted on by Congress, determines how much the nation
spends each year on its programs and whether it will
have a deficit or surplus. When Congress votes to
increase the debt ceiling, it is because it has already
promised to spend more than is available.
If Congress were to disallow an increase the debt
ceiling, the government would be forced to stop
Fiscal conservatives often criticize the first option, raising
taxes, because it increases the amount of money the
government takes out of the private sector. With fewer
dollars to go around the system, people spend less and
the economy slows down. However, the other option,
cutting spending, can be just as bad for an economy as
it reduces the amount of money the government puts
back into the system.
In addition to these public methods, the government also
possesses the ability to inflate its currency and pass
over its debt. Because the government owes money in
fixed dollar amounts, it could simply print money until it
has enough to pay off its debts. This too is not a viable
option—it would lead to a sharp rise in inflation that
would destroy the national economy.
Limitless Budget?
The U.S. government’s spending record has led many
people to suggest a repeal to the debt ceiling. While the
idea of allowing the government to have limitless debt
spending concerns many citizens and investors, the
actual process of raising the debt ceiling is typically little
more than a formality in Congress. As stated, the U.S.
budget determines the planned expenses of the nation,
while the debt ceiling only hampers the Department of
the Treasury from taking quick action. Nevertheless,
many proponents of keeping the debt ceiling cite that it
serves as a regular reminder to Congress of how
important it is to balance the budget.
Planning Ahead
Regardless of U.S. spending habits, individuals should
never allow themselves to overreact to speculations
about the future. With the current world economy
functioning in an unprecedented way, it is almost
impossible to predict what will happen with the debt
ceiling and how exactly it will affect the economy.
Despite the unknown, preparation always yields benefits
for finances. Everyone should take steps to secure their
present and future needs as early as possible. It is
important to recognize that investing carries certain risks
and that both ups and downs are to be expected.
Eventually, the government will have to change its
approach to its debt. Not surprisingly, these unknown
changes will bring further unknown consequences. By
staying current on congressional decisions, individuals
can better prepare for changes in interest rates or
monetary value.
As U.S. spending habits move into uncertainty,
knowledge becomes power. Experienced advisors have
the knowledge to understand how market shifts affect
your future. Regular consultation with your Northern Oak
Wealth Management, Inc. financial advisor can help
strengthen your portfolio for almost any fiscal climate.