What’s with the U.S. Debt Ceiling issue?

James Ryan Jonas

One of the most highly controversial topics in the United States right now is the Debt Ceiling issue. Basically, U.S. lawmakers are debating whether they should increase the country’s debt ceiling and, if yes, by how much. Much of their disagreement and discussion focus on the policy implications once the limit is raised.

Background of the Debt Ceiling Issue

Like any regular sovereign state, the United States relies on borrowings to finance its spending. In fact, the United States is the #1 borrower in the world, with total external debt amounting to $14.3 trillion as of May 2011.

That’s where the problem lies. The United States is limited by law to borrow a certain amount. This limit, or debt ceiling, is currently pegged at $14.3 trillion. However, according to the U.S. Treasury, this limit was reached in May 16, 2011 and the country only has enough money to spend until August 2, 2011 — a few days from today.

Impact if the Debt Ceiling is not raised

If the U.S. Congress fails to raise the debt limit, the United States would be forced to cut spending and may also default on its loan obligations.

If this happens, the United States would have to halt spending on social services and infrastructure projects since it has no more money and it cannot borrow anymore. Barclays Capital warns that the Treasury may completely run out of cash around August 10, when $8.5 billion in Social Security payments are due.

Interest payments on current debts may also have to be deferred, effectively causing the United States to default on its loans. Such default would lead to catastrophic results in the U.S. stock and bond markets, ultimately affecting the global markets as well.

According to former Treasury Secretary Lawrence Summers, not raising the debt ceiling could result to the following scenarios:

  • higher borrowing costs for the U.S. government (as much as 1% or $150 billion/year in additional interest costs); and
  • the equivalent of bank runs on the money and other financial markets, potentially as severe as September 2008

Debate on the Debt Ceiling

If the impact of not raising the limit is expected to be catastrophic, why don’t U.S. lawmakers simply lift the ceiling ahead of the August 2 deadline? Most U.S. Congress lawmakers pretty much agree that the debt ceiling has to be raised, however, they differ regarding the implementation of the plan and the resulting policy changes.

Initially, President Barack Obama and the Democrats proposed to raise the ceiling with no conditions attached such as spending cuts. On May 31, the bill failed when 318 members of the House of Representatives voted against it, with only 97 approving the proposal.

The debates ensued, focusing on consequent strategies to cut the country’s deficit as a requirement for raising the debt ceiling.

On one side, there are the Republicans calling for a reduction in government spending that will supposedly reduce the deficit by around $3 trillion. The move will be accompanied by lower taxes in order to revive the economy.

On the other side are the Democrats who prefer not to reduce spending but to generate revenues instead by collecting more taxes from businesses and high networth individuals. They also claim that additional savings of more than $1 trillion would be gained when the U.S. ends its wars in Afghanistan and Iraq.

Test of Leadership for Obama

Pres. Barack Obama’s second terms hangs in the balance while the debt ceiling issue is being debated. The President cannot afford to easily concede to the demands of the Republicans lest he wants to appear too weak. At the same time, he needs to convince the Republican-controlled House to raise the debt ceiling, otherwise, non-approval could send the United States to a loan default leading to another possible round of economic recession, effectively dooming his second chance at the presidency.

The impasse is taking a toll on Obama’s approval ratings. A CBS News poll in June shows 48% of Americans approve of the way he is doing his job, down nine points when he got a 57% approval rating after announcing that Osama bin Laden has been killed.

With less than five days before the August 2 deadline, we wait with bated breath what will happen next.

James Ryan Jonas teaches business management, investments, and entrepreneurship at the University of the Philippines (UP). He is also the Executive Director of UP Provident Fund Inc., managing and investing P3.2 Billion ($56.4 Million) worth of retirement funds on behalf of thousands of UP employees.