Strategy

Dancing on the debt ceiling

The U.S. government is again coming up against its debt ceiling, but this time Congress may refuse to increase its credit limit.

Could the United States default? Treasury Secretary Timothy Geithner says it could happen as early as this spring. In January, he warned the U.S. Senate in writing that unless Congress acts swiftly, American soldiers deployed worldwide might stop receiving paycheques. Interest payments on U.S. Treasury bonds could cease, as might unemployment and Medicaid benefits to states. The fallout would make the collapse of Lehman Bros. seem like the closure of a corner pizzeria by comparison. “Even a very short-term or limited default would have catastrophic economic consequences that would last for decades,” Geithner wrote.

Geithner’s problem is that he’s nearly maxed out his line of credit. For almost a century, Congress, which has absolute power over all fiscal matters by virtue of the U.S. Constitution, has for nearly a century imposed a hard cap (also called the “debt ceiling”) on the amount of debt the Treasury can have outstanding. This statutory debt limit now stands at US$14.3 trillion — a level Geithner predicts will be reached sometime between April 5 and May 31. At that point he will be unable to issue bonds to meet America’s obligations.

Geithner wants more headroom. Unfortunately for him though, Republicans won a majority in the U.S. House of Representatives in November’s mid-term elections, and many — particularly those endorsed by the Tea Party movement — are spoiling to rein in government spending, and they see the debt ceiling as the fulcrum. In early January, Republican Sen. Jim DeMint called on fellow conservatives to just say no. “We need to have a showdown that we’re not going to raise our debt ceiling anymore,” he told Human Events, a conservative magazine, in an interview. “We are going to cut things necessary to stay within the current levels.”

Impossible, Geithner retorts. Although in years past the Treasury used extraordinary measures to forestall default while Congress bickered, this time such tactics would buy a few weeks at most, he claims. Even draconian cuts to federal spending wouldn’t do the trick. Indeed, recently the Congressional Budget Office declared that if current laws remain unchanged, the U.S. will rack up a staggering US$1.5 trillion deficit this year.

This might seem a historic moment, until one recognizes that many of his predecessors regularly wrote similar missives. The debt ceiling was introduced in 1917, at a time when America was issuing copious amounts of debt to finance its entrance into the First World War. The convention was to rack up debt only in times of war or serious economic crises, and to pay it down afterward. But after Second World War, repayment became exceedingly rare, necessitating frequent ceiling increases. By the 1980s, votes were sometimes just months apart. As Geithner wrote in his letter, “Never in our history has Congress failed to increase the debt limit when necessary.” Indeed, Congress raised the ceiling well over 70 times in the past half century. Nobody seems particularly worried about the votes — bond markets barely react.

But Alice Rivlin, a former Congressional Budget Office director who now works at the non-profit Brookings Institution in Washington, perceives a genuine risk that Geithner won’t get more credit this time. “We have new people in Congress who are very adamant about deficit reduction,” she says, “and not very sophisticated about the consequences of defaulting on the debt.” And even if Congress does raise the ceiling once again, these disputes will arrive more frequently — and likely prove harder fought — as America’s fiscal train accelerates out of control.