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Debt Ceiling Fight Risks Unprecedented Economic Turmoil

Isaac Nuriani    |
Aug 13, 2021

Did you know there’s a limit on the size of the national debt? At least there’s supposed to be. But when it comes to the debt, all we ever seem to hear about are soaring numbers and new record highs.

The limit on the national debt is known as the debt ceiling. You’ve probably heard the term. You likely are hearing about it right now as Democrats and Republicans furiously fight over whether to raise the debt ceiling once again and allow the government to engage in the all-important practice of borrowing in order to pay bills.

The debt ceiling was suspended two years ago as part of a budget deal between the Trump administration and Congress, with the stipulation it be reintroduced effective to whatever the total national debt is on August 1, 2021 (a little more than 28.4 trillion dollars).1 Treasury has about two months’ worth of resources (more about that shortly) to continue meeting key obligations but still has to begin suspending payments to other obligations so it can to conserve available resources.

Contentious fights over the debt ceiling have come up before. And, while it would be nice to think those fights primarily are started by both parties wanting to see fiscal responsibility reign throughout the land, that isn’t the case. Debt ceiling fights – like all fights in Washington – are divided along political lines.

This time around, the GOP has vowed not to participate in raising the debt ceiling to accommodate what it sees as a particularly reckless and philosophically disagreeable (to Republicans) Democratic spending agenda. For an increase to pass, 60 senators will have to be on board – which necessarily means 10 Republicans among them.

In general, major Washington-level political upheavals have the capacity to wreak some measure of havoc on markets and overall economic stability. But a fight over the debt ceiling could have particularly dire consequences. Ultimately, if the debt ceiling is neither raised nor suspended, it means the U.S. government soon will have to begin defaulting on its debt. If that happens, the likely result – according to the U.S. Treasury and even Treasury Secretary Janet Yellen – would be a global financial crisis of great magnitude.

The Debt Ceiling: A Brief Primer

To positively no one’s surprise, the federal government borrows to spend money. Of course, the government also relies on taxation to help generate the funds required to pay for everything it wants. But the funds cultivated from borrowing also are a must-have.

The debt ceiling essentially is a relic from a time when we held financial prudence in much higher esteem than we do now. Before 1917, the government had to get congressional authorization to borrow a specific sum of money. No additional funds could be borrowed until that money was repaid and Congress reauthorized the borrowing of another sum.2

The First World War changed that. Wanting to ensure President Wilson had ready access to funds for the war effort, Congress passed the Second Liberty Bond Act of 1917, which loosened borrowing restrictions. Congress did not want to effectively grant the president the ability to borrow an unlimited amount, however, and created the debt ceiling as a part of the legislation.3

Since its institution, the debt ceiling has been raised or suspended numerous times to accommodate the “need” for ever-greater levels of government borrowing. As I mentioned earlier, the last adjustment was two years ago, when a Trump-Congress budget deal suspended the ceiling until August 1.

So when the limit is reached, how come the government doesn’t immediately begin defaulting on its obligations? Remember: Taxation also creates trillions per year in revenue for the federal government. That tax revenue – along with whatever sundry cash the government has available – can be used to meet key obligations until the money runs out.

Even at that, however, so-called “extraordinary measures” have to be put in place by the U.S. Treasury (the government’s check-writer) to help ensure those key obligations can be met for as long as possible. Among these “extraordinary measures” is a suspension of government contributions to various retirement funds, which would be made up later assuming a favorable debt-ceiling resolution comes to pass.

At current levels, it’s estimated tax revenue and other available cash fiscally gets the country to around October. And if there’s no deal to raise the debt ceiling by then, that’s when real trouble could arise, because the only resources the government would have then to pay its bills are daily tax receipts. The government would have no choice but to begin defaulting on its obligations.

Janet Yellen: Default on National Debt Would Trigger “Catastrophic Consequences”

If you surf the internet in search of a description of the potential consequences that could arise from the U.S. defaulting on its obligations, you will come across illustrations of the very ugliest global economic scenarios.

Do you think such illustrations are merely a contrivance designed to scare Americans like you? Maybe a description of the projected consequences from the U.S. Treasury itself might change your mind about that—so you know this is a very real concern:

The United States has never defaulted on its obligations, and the U. S. dollar and Treasury securities are at the center of the international financial system. A default would be unprecedented and has the potential to be catastrophic: credit markets could freeze, the value of the dollar could plummet, U.S. interest rates could skyrocket, the negative spillovers could reverberate around the world, and there might be a financial crisis and recession that could echo the events of 2008 or worse.4

In a recent personal statement on the ongoing debt-ceiling standoff, Treasury Secretary Janet Yellen said that a failure by the government to meet its obligations “would cause irreparable harm to the U.S. economy and the livelihoods of all Americans.”5 And in June testimony before the Senate Appropriations subcommittee, Yellen said a default on the national debt should be considered “unthinkable,” because it would yield “absolutely catastrophic consequences” capable of triggering a financial crisis.6

Notice that these descriptions of the dire consequences facing the U.S. and global economies are not preceded by the word “could” – but “would.”

Gold and Silver Could Help Mitigate Volatility to Savings If Debt-Ceiling Standoff Persists

Those who have followed gold and silver for some time might have had opportunities before to take a second look at the U.S. Treasury’s reference to the 2008 financial crisis. Retirement savers often point to the years of the ’08 debacle as one of the better examples of precious metals’ capacity to thrive during genuine crisis conditions: From 2008 to 2011, gold and silver climbed 160% and 400%, respectively.

Despite Treasury’s comparison to the effects of the 2008 financial crisis, of course there’s no way to know for sure if a bona fide debt-ceiling crisis would prompt precious metals to appreciate in the same way. But given the nature of those possible consequences, it’s not unreasonable to consider the possibility that gold and silver could strengthen significantly amid such profound turmoil.

Some observers dismiss the possibility the government actually would default on its obligations by pointing to the fact it hasn’t happened yet despite previous debt ceiling showdowns. But I believe this time around could be different. In my view, Republican lawmakers are fed up over what they see as a Democratic fiscal outlook entirely devoid of even a shred of prudence or responsibility.

Plus, it’s worth noting that it doesn’t take an actual default to roil the economy and markets. In April 2011, Standard & Poor’s downgraded the credit ratings of the U.S. government for the first time in history. Also, Treasury points out that as the 2011 debt-ceiling standoff persisted, the S&P 500 fell about 17% and did not recover until 2012.7 Not a terribly lengthy period, but here’s the point: If Republicans mean business this time and really give no ground to Democrats who are single-mindedly devoted to their agenda, there’s no telling just how much damage could be done to markets and the overall economy even if an actual debt-ceiling deal eventually is reached.

1 Ed Kilgore, New York Magazine – Intelligencer, “Why Congress Is Fighting Over the Debt Ceiling Yet Again” (August 6, 2021, accessed 8/12/21).
2 Steven Pressman, The Conversation, “Why America has a debt ceiling: 5 questions answered” (July 23, 2021, accessed 8/12/21).
3 Ibid.
4 U.S. Department of the Treasury, “The Potential Macroeconomic Effect of Debt Ceiling Brinkmanship” (October 2013, accessed 8/12/21).
5 U.S. Department of the Treasury, “Statement from Secretary of the Treasury Janet L. Yellen on the Debt Limit” (August 9, 2021, accessed 8/12/21).
6 Martin Crutsinger, AP News, “Yellen: Failure to raise debt limit would be ‘catastrophic’ (June 23, 2021, accessed 8/12/21).
7 U.S. Department of the Treasury, “Potential Macroeconomic Effect.”

 

 

 

 

 

 

 

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