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Abolish the Debt Ceiling

Much talk in recent weeks has been about the need for Congress to once again raise the debt ceiling, otherwise risk widespread default on US government debt.

If you are experiencing some déjá vu, you are not alone. Debt ceiling standoffs have become a staple in American politics in recent decades, with one party using the debt ceiling to play the proverbial game of chicken with the US economy, and the other hoping a deal is hammered out before it’s too late.

But why exactly do we have a debt ceiling? What is its purpose, and is it being used in a way that achieves that purported goal?

The debt ceiling was created in 1917, via the Second Liberty Bond Act, as a way to limit the amount of debt the US government could have outstanding at any given time. To those who firmly believe in its purpose, it has served as a check on out-of-control government spending and an ever-expanding public sector. To others, it has created more problems than it solves.

Now you may be surprised to learn there are actually good reasons to raise the debt ceiling. For instance, as the economy grows, tax revenues will likely grow, but a growing economy also puts pressure on elected leaders to provide more goods and services for their constituents. This is logical; as a country becomes wealthier, citizens should expect more from their government, and this could, in turn, add to the debt over the long-term. Think Social Security and Medicare. At their inception, both were programs we could easily afford. Now they are a drain on revenues.

But let's make no mistake here, the US Treasury markets have allowed the US economy to safely live beyond its means for more than a century. They have served as the conduit to financing necessary wars and funding an expansive national security network; they have allowed politicians to provide much needed social services for those who have been left behind economically; and they have helped end numerous economic downturns.

So why is there such animosity towards letting our debt increase as our economy naturally grows larger? Yes, the national debt is growing much faster than the overall economy, leading many to believe the current trajectory of debt can’t go on forever and that there must be some limit to this relationship. But it’s important to keep in mind that no country really ever pays off its debt; they just roll it over into new debt. The real threat is not nominal outstanding debt but whether a government can safely service its debt, and the easiest way to determine if a country can prudently service its debt is by looking at three key metrics: monetary sovereignty, market interest rates, and economic growth.

The first metric, monetary sovereignty, is more of a technical consideration than anything really to do with economics. The basis of it: does the country in question issue debt in the same currency it controls? For the US the answer is yes. The US Treasury issues debt in US Dollars and the Federal Reserve controls the supply of US Dollars. So, in the worst of scenarios, the Federal Reserve could monetize (buy) all US Treasury issuances (assuming there are no buyers in the open market) and the federal government would carry on unencumbered. In practice, this would never happen, and there are certainly inflation considerations in doing this, but from a practical standpoint, it’s doable—the Fed is already a major player in Treasury markets through normal open market operations (interest rate policy).

The second is market interest rates. The important consideration here is whether market makers have priced in the likelihood of a US default. For bond investors, the two metrics to consider are interest rate risk and default risk. If market makers believe a default is likely, interest rates will be high and bond prices will be low. Neither of which is the case for US bills, notes, or bonds at present.

The third feature is economic growth. Is the economy growing? Are tax revenues going up? Again, the US is fine in this regard. Growth is high this year, and even though inflation is starting to pick up a bit, the economy is on a steady growth path.

Having said all of this, some very educated economists will tell you that what really matters is the ratio of US Debt-to-GDP, and that it is skyrocketing because of Covid-19 fiscal stimulus and continual peacetime deficits—and that we should be concerned. We shouldn't. For decades, the Debt-to-GDP metric has been a problematic metric for numerous reasons. Economists used to believe that a debt-to-GDP ratio above 100% would be a real cause for panic, but many developed countries run debt-to-GDP levels above 100% and have no reason to be alarmed. Why? Because they can easily service their debt.

Now, a point I feel needs to be addressed: raising the debt ceiling is not a license to borrow more money. It is a legal procedure that allows the US government to pay back the money it has already borrowed. We should stop interpreting it as a government credit card, which by increasing its limit, Congress can somehow go on a spending spree and bankrupt the country. The simple truth is that the only scenario in which the US economy could ever go bankrupt is when Congress chooses not to raise the debt ceiling. The US will always be capable of servicing its outstanding debt. Yet, for some bizarre reason, we hit the debt ceiling every other year, are forced to hear lectures on fiscal responsibility from politicians with little-to-no understanding of public finance, and then hope to God these same people don't crash the global economy.

It's time to abolish the debt ceiling.


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