Once again, the United States government is running up against the debt limit, a statutory limit on the amount of debt that the United States can issue. Right now the Treasury Department is using some accounting gimmicks to avoid hitting the debt limit. But by September or October those steps will prove inadequate, and unless Congress acts to raise the debt limit, the United States would face a crisis that could dramatically raise borrowing costs throughout the economy and cause a recession.
The good news is that the repercussions of not increasing the debt limit are so severe, Congress is likely to raise it in the months ahead.
Right now the debt ceiling is about $22 trillion, but the federal government will soon hit that because federal spending is much greater than federal revenues, and the government is borrowing to make up the difference, taking on more debt.
Who Would be Affected
If the government were to hit the limit it wouldn’t be able to meet all of its obligations; spending would have to fall to meet revenues. It is unclear if the federal government could legally prioritize its outlays, or instead would pay bills as they come in, but all sorts of federal spending would face the chopping block: defense outlays, salaries for federal employees, spending on health and safety, Social Security benefits, and perhaps most dangerous, interest payments on the federal debt.
The concern is that hitting the debt limit would mean that holders of U.S. government debt, both domestic and foreign, wouldn’t be assured of getting their interest and principal payments. U.S. Treasuries are the most liquid, most secure financial assets in the world, keeping borrowing costs in the U.S. low.
But an effective default if the U.S. hits the debt limit would wipe out that reputation. That would raise interest rates instantaneously, not just for federal government borrowing, but also for borrowing by state and local governments, businesses and households. The shock could be enough to throw the U.S. and global economies into recession. And a debt limit crisis could cause permanently higher U.S. interest rates, leading to slower long-run economic growth that would reduce Americans’ ability to enjoy a higher standard of living over time.
It is traditional for Democratic members of Congress to threaten to vote against the debt limit when a Republican holds the White House, and vice versa, in an effort to appear fiscally responsible and embarrass the other party. Historically as the deadline approaches and the threat of default becomes more real, both sides back down and Congress votes to increase the debt limit. That will almost surely happen this time as well.
How to Prepare
It makes sense to look at your business’s overall debt level, and mix of fixed- and adjustable-rate debt, in the months leading up to any debt limit decision. Although the outlook is positive at this time, it never hurts to prepare.