Political Tool Returns After One Year Vacation: Debt Ceiling

The Debt Ceiling is back-here's what that actually means.

The debt ceiling returned Monday, along with warnings the US will default unless Congress raises it before the Treasury's spare cash runs out. It's a foregone conclusion Congress will comply at some point, as they have 109 times since its 1917 inception. But how they do it is anyone's guess. Maybe they'll do it with little debate and no fanfare, like 2012! Or maybe they'll have a knockdown drag-out, a la 2011 or 2013 (or 1985-debt ceiling fights aren't new). Congress isn't split this time, but they could still have a standoff with the White House, and intra-party bickering is always possible. If it does get noisy, fear not: These debates are political grandstanding, nothing more, and delayed action won't trigger default.

Today, the debt ceiling is an annoyance, but it wasn't intended to be. Initially, it was a convenience, designed to spare Congress the drudgery of approving each bond issue needed to fund World War I operations. In the intervening decades, it has become a political tool: a lever for parties to extract concessions from the opposition or to manage their own appearance to voters.

After 2011's debt ceiling fight drove credit rater Standard and Poor's to strip America's AAA credit rating, Congress passed the Budget Control Act, which allowed for three debt limit increases at Presidential request. Congress would have to pass bicameral acts disallowing the second two increases, which didn't happen. We guess they (temporarily) tired of the theatrics, because in early 2013 the debt limit was unceremoniously suspended until May, when brinksmanship began anew-continuing through October's big debate and semi-related government shutdown. Last February, another quiet suspension followed, then another. This last suspension is the one that expired March 14. That's how we got where we are-with debt at the new limit and nary a "raise it" bill close to a vote. What gives?

Congress knows they don't need to raise the ceiling right when it is hit. First, the Treasury can use "extraordinary measures" to keep things running smoothly without issuing debt. These are essentially accounting entries and include things like:

  • Suspend the daily reinvestment of Treasury securities held by the G-Fund, a fixed-rate option government employees can purchase in their retirement plan (known as a 457 plan).
  • Suspend investments in the Exchange Stabilization Fund, a fund used to intervene in foreign exchange markets if necessary, like the 1994 Mexican Peso Crisis.
  • Suspend investments in the Civil Service Retirement and Disability Fund, which are replaced when the debt ceiling is raised.

The rhetoric gets hotter once those extraordinary measures near expiration. In 2013, the US hit the ceiling in May. But the debate didn't hit full steam until September, when the Treasury said extraordinary measures would run out, forcing it to operate with cash on hand (and warning Very Bad Things loomed). This time, the Congressional Budget Office estimates extraordinary measures can run through October or November, so Congress has some time to ... ummm ... deal with this issue. (Read: Bicker.)

Some politicians are already warning America will default if this isn't addressed on time, but that's false advertising. Default means failing to make timely interest or principal payments on debt, a contractual obligation. In the US government's case, debt means Treasurys, and since the debt ceiling allows issuance to refinance maturing debt, the issue is interest, and it isn't much of an issue. US debt interest payments comprised only 7.8% of tax revenue in fiscal 2014. Revenue received during each month far exceeded the month's interest payments.

The government could easily cover interest with new revenues if they prioritize debt payments over other expenses, which is basically a must. The 14th Amendment, Section 4 of the US Constitution states the validity of US debt shall not be questioned. The Supreme Court in 1935 interpreted this as ordering the Treasury to make debt payments above all else, which the nonpartisan Government Accountability Office backed during that 1985 debt ceiling fight. If push came to shove, the Treasury would have to make some choices. After paying interest due, recent statements show tax revenue could easily cover Social Security, Medicare and Defense Department outlays plus some. So the Treasury would probably start by delaying non-urgent items. Tax refunds. Grants. National parks would probably close. The Smithsonian almost surely would, and some reporter would likely take a photo of it. Annoying for those impacted? Sure. A gargantuan economic crisis? Extremely unlikely. Default? Nope.

Again, Congress could render this all moot by passing something quick and quiet. But if not, don't get sucked into default dread.

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*The content contained in this article represents only the opinions and viewpoints of the Fisher Investments editorial staff.