Economic Concepts
How the Debt Ceiling Works
What Happens If Congress Doesn't Raise the Debt Ceiling?
To understand what would happen if the U.S. Congress didn't raise the debt ceiling, let's go back to the credit card analogy. If you borrow the maximum $10,000 allowed by your credit card, you will need to do everything in your power to avoid going into default, which would ruin your credit rating. You can try to drastically cut your personal spending, get a second or third job to increase revenue, or borrow the money from someplace else, probably at a higher interest rate.
If Congress decides not to raise the debt ceiling, the federal government runs the same risk of going into default and damaging its credit rating. Up until now, the world has treated the U.S. Treasury like an international piggy bank, the safest place to invest money during an era of global economic uncertainty. When a foreign government needs cash, it can simply redeem a few million dollars in U.S. Treasury bonds.
But what if the Treasury doesn't have enough money to back its bonds? At worst, it could default on some of its debts, which could send global markets into a panic. But even if the government avoids a full default, it could lose its AAA credit rating. That means that creditors could demand higher interest rates. When the base interest rate on Treasury bonds goes up, other interest rates are likely to follow, like those attached to home mortgages or business loans [source: Davidson]. Higher rates would discourage investment, creating a huge drag on economic growth in the U.S.
Also, if Congress opted not to raise the debt ceiling, it would be forced to live within a budget. That would likely mean deep, across-the-board spending cuts and massive scale downs of popular programs like Social Security and Medicare. It would also likely mean raising taxes significantly.
Until those spending cuts and tax hikes took effect, the Treasury would have to decide which bills to pay first with its dwindling funds: interest on the national debt or Social Security payments? Tax refunds or Medicare reimbursements? All of these scenarios would likely trigger a massive political backlash from voters in both parties.
That's our brief explanation of how the debt ceiling has evolved from a convenient instrument for managing government borrowing into a political powder keg. For lots more information on the national debt, personal budgeting and credit cards, check out the related links below.
Author's Note: How the Debt Ceiling Works
While researching this article, I came across an illustration that encapsulates the whole debt ceiling debate in a single image. A twitching finger — presumably belonging to a rattled Congressman — hovers above two toggle switches. The first, in calming blue, says, "Raise the Debt Ceiling." The second, in alarming red, reads, "No More Debt." If Congress throws the red switch and fails to raise the debt ceiling, the short-term economic shock waves could be violent. Over the long term, it's not hard to imagine a world in which the dollar is no longer the default currency, and the U.S. cedes its superpower status to the Chinas and Brazils of the world. But what about the danger of throwing the blue switch, again and again and again? Is it sustainable to let China and Japan continue to pay our bills? The price of living without debt would likely mean harsh economic austerity and a downgrading of the American dream. It's painful to watch dreams die, but what if the only other option — spending and borrowing ad infinitum — turns out to be an even more dangerous fantasy?
What's the difference between the U.S. deficit and the national debt?
How Debt Works
How Credit Cards Work
Does your credit card company want you to stay in debt?
How Federal Taxes Work
Austin, D. Andrew; and Levit, Mindy R. "The Debt Limit: History and Recent Increases." Congressional Research Service. Sept. 25, 2013. (Oct. 14, 2013) http://www.fas.org/sgp/crs/misc/RL31967.pdf
Davidson, Adam. "Our Debt to Society." The New York Times. Sept. 10, 2013. (Oct. 14, 2013) http://www.nytimes.com/2013/09/15/magazine/our-debt-to-society.html?pagewanted=all&_r=0
Federal Reserve. "Factors Affecting Reserve Balances." Oct. 10, 2013. (Oct. 14, 2013) http://www.federalreserve.gov/releases/h41/Current/
Hirsch, Paddy. "Debt ceiling is like a credit card? Think again." Jan. 18, 2013. (Oct. 14, 2013) http://www.marketplace.org/topics/world/whiteboard/debt-ceiling-credit-card-think-again
Sherter, Alain. "Debt ceiling: Understanding what's at stake." CBS MoneyWatch. Oct. 7, 2013. (Oct. 14, 2013) http://www.cbsnews.com/8301-505123_162-57606253/debt-ceiling-understanding-whats-at-stake/
U.S. Department of the Treasury. "Debt Limit: Myth v. Fact." May 2011. (Oct. 14, 2013) http://www.treasury.gov/initiatives/Documents/Debt Limit Myth v Fact FINAL.pdf
U.S. Department of the Treasury. "Historical Debt Outstanding — 2000 – 2012." (Oct. 14, 2013) http://www.treasurydirect.gov/govt/reports/pd/histdebt/histdebt_histo5.htm
U.S. Department of the Treasury. "Major Foreign Holders of Treasury Securities." (Oct. 14, 2013) http://www.treasury.gov/resource-center/data-chart-center/tic/Documents/mfh.txt
Wessell, David. "The Debt Ceiling Explained: Why You Should Care." The Washington Post. Feb. 4, 2013. (Oct. 14, 2013) http://live.wsj.com/video/the-debt-ceiling-explained-why-you-should-care/40415F7F-C0EB-4048-9612-42A22EB77D66.html#!40415F7F-C0EB-4048-9612-42A22EB77D66
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