MainStreet Macro: A short-term fix

Every now and again something distracts me from Main Street businesses, consumers and employees. Today, my attention is directed toward Pennsylvania Avenue in Washington, D.C. There, until last week, the Treasury Department was facing dire consequences as Congress fought over raising the debt ceiling.

The urgency of the moment has passed after lawmakers in Congress approved a short-term fix to raise the debt ceiling enough to fund government spending through Dec. 3. 

What happens next? Glad you asked. This week, we tell you three things every Main Streeter should know about the debt ceiling.

What is the debt ceiling?

Put simply, the debt ceiling is about what the U.S. owes people. More specifically, it’s a limit to what the federal government can spend over and above what it collects in taxes and other revenue.

Currently, the national debt is around $28.5 trillion or about 125 percent of GDP. Much of this debt is held by U.S. citizens in the form of government bonds, or Treasurys. Foreign investors, too, are active purchasers. And a small portion of the debt is held by the government itself. 

People flock to purchase Treasurys because the U.S. is the most stable financial system in the world. The high demand is a sign that investors, both foreign and domestic, are confident that the U.S. government will repay its debts, even during economic downturns like the one we just experienced.

But the Treasury can issue bonds to pay for federal spending only up to a certain limit — the debt ceiling.

Congress sets that limit. The process for raising it used to be routine, with no more drama than you’d experience renewing your driver’s license. Yes, it’s a nuisance, but your legal ability to keep driving is never really in doubt.

In recent years, however, the process of raising the debt ceiling has become politicized. In 1995, 2011, 2013, and now 2021, the debt ceiling has been an innocent bystander in congressional debate over spending priorities.

But let’s be clear: Raising the debt ceiling allows the Treasury only to fund spending that Congress already has voted on and approved. It doesn’t grant the government permission to increase spending.

The current system — in which Congress signs off on federal spending first and then asks the Treasury to pay for it later — is like taking your credit card on a shopping spree and then asking your credit card company after the fact to raise your credit limit.  

Whether your limit is raised or not, you’re already rockin’ those cool new boots and the bill needs to be paid.

Why is this a problem for Main Street now?

The U.S. was running annual deficits well before the pandemic. However, the $6 trillion in federal spending that helped prevent a deep and prolonged economic depression added to the U.S. debt.

And that spending came after Congress passed a large tax cut for businesses and households in 2017. Tax revenues, as a result, have fallen even further behind spending increases. 

Emergency spending tied to the pandemic is an important near-term component of the budget, but longer-term issues dwarf it by comparison.

Roughly 70% of federal spending is mandatory. And about half of federal dollars goes toward Social Security, Medicare and Medicaid. Those entitlement programs are expected to take an even bigger bite out of GDP in the future as the U.S. population ages and health costs increase.

The Congressional Budget Office projects that the U.S. debt will double in the next 30 years.

Source: Congressional Budget Office, July 2021

What happens if Congress doesn’t raise the debt limit?

To be honest, no one really knows because it’s never happened. Since Congress invented the debt ceiling in 1917, lawmakers always have raised it to fund spending that they’ve already authorized.

Once the ceiling is hit, however, the Treasury can no longer borrow. That’s when things get serious.

The government would have to choose what bills to pay and not pay. Would it continue making principal and interest payments on current debts to prevent the global financial chaos that surely would ensue in the event of a U.S. default? Might the Treasury prioritize Social Security and health care coverage to senior citizens and vulnerable populations? Or should the money first go to paychecks of U.S. troops that protect and defend the country?

These are decisions no government wants to be forced to make. That’s why raising the debt ceiling has always been considered the only viable course when spending needs increase. And it’s the most likely outcome, even now, when deadlines loom.

My Take

Congress bought itself some time last week, but it hasn’t solved any underlying issues. Until the system changes, there’s always the risk of another game of chicken on the debt ceiling.

I was on Capitol Hill in 2013 three days before the debt ceiling was about to be breached, testifying to the House Financial Services Committee as part of a panel of Wall Street analysts.

Like some of the other private-sector panelists, I thought the chance of a debt ceiling breach was near zero given the potential for catastrophic consequences.

However, I came to understand that day that Congress also pays a price for pushing too close to its deadlines. That game of chicken is itself a risk to the safety and soundness of the financial system in the U.S. and globally.

In short, the debt ceiling debate masks the real challenge before Congress. Spending is going up.  People are aging and will need a higher level of public support than ever before. How the country addresses the issue of rising federal debt tied to skyrocketing spending and stagnating revenues is a critical issue of national importance. There’s no short-term fix for that.