What Is The Debt Ceiling

The United States Debt Ceiling Keeps Getting Higher

The US debt ceiling has been getting higher for years.  It became a hot topic in 2011.
The US debt ceiling has been getting higher for years. It became a hot topic in 2011. | Source

The Debt Ceiling Debate Heats Up

The debt ceiling debate really heated up after the Fiscal Cliff scenario of 2012 played itself out. The debate over how high the US national debt limit, or debt ceiling, should be is one that has been going on for a long time. Ever since it was first enacted the limit, or target as some put it, has been raised multiple times. Each time the subject come up the politicians argue until in the end, it goes up. Just what is the debt ceiling though? Where did it come from? What is for and why do we keep raising the limit.

The Definition Of Debt Ceiling

Debt Ceiling - The maximum borrowing power of a government or governing body. In the US the debt ceiling is the amount of national debt the US is allowed to have. This limit is set by congress and is an arbitrary figure that is debated and updated annually.

US Debt By Sectors Since 1975

Total US debt has been growing across all sectors since 1975.
Total US debt has been growing across all sectors since 1975. | Source

What Is The US Debt Ceiling

The debt ceiling is a part of the US economy that first gained the public spotlight in 2011 and continues to raise heated debate. By definition the debt ceiling is the maximum amount a country can borrow. Because the government spends more than it makes in each year the amount of debt the government carries from year to year has been increasing causing the US to reach its debt limit. The ceiling is currently set at $16.394 trillion; if the US were to reach that limit, which would prevent the treasury from issuing new bonds, it would then be in default on it's debt obligations.

The debt ceilingitself is a number set by Congress. It is not permission for the government to spend more money; it is permission for the Treasury Department to issue new bonds in order to raise money to pay for current debts. If the treasury can't raise new money to cover these debts the government would be forced to cut spending, in effect causing a partial shut down of the government. These two issues, the amount of debt limit and the amount of spending, are at the heart of the Debt Ceiling debate.

The ceiling was an often agreed upon fact of government operation until divisions between the parties grew. Now, the divide between fiscal responsibility and government spending has pushed the issue into the spotlight. It began in 2008-9 when the financial crisis caused the President to enact broad spending measures. It came to a head in 2010 when the Tea Party sent their message to Congress: cut spending and reduce taxes.

This was followed in 2011 when the Republican Party dug in their heels over the Federal Budget. Now, the Republicans are standing firm on long term spending reductions in order to help curb the national deficit. Democrats are clinging to the need for government spending in order to help stimulate and drive economic growth.

The Congress has not been able to sign off on a national budget for several years. The issue has come to several critical junctures in which stop-gap measures have had to be put in place. The process of enacting these measures is complicated and can be done by either the President or the Congress with either party have some veto powers over the other.

The United States Raises Money Through Bonds

There are three primary ways for the United States to raise money. The first and most obvious is to print it. This is not the best way for any country to raise capital and comes with many problems. Most countries choose not to print more money because it weakens the currencies value in exchange for other world currencies and because it causes inflation. If there are more dollars in the world then it takes more dollars to buy things, but I digress.

Not counting the printing press the US Treasury can raise money in two ways: taxes and debt. The US spends about $3.5 trillion each year, according to recent statistics, and only brings in roughly $2.4 trillion in taxes and other revenue. The US must make up the roughly $1.1 trillion deficit with public debt. This is done by selling US Government Bonds, widely considered to be the safest investment available. Bonds are offered on short, medium and long term basis with interest yields corresponding to time to maturity. Bonds are offered at auction and traded on the floor of the bond exchange much like stocks and commodities.

What Is Government Debt

Debt, and more specifically government debt, is what the Debt Ceiling debate is all about. The US government spends trillions of dollars each year. A large portion, most in fact, of the money spent by the US government is raised by taxes. The remainder is raised by debt. Because a governments, unlike a person, can not just go out to the bank and get a loan they have to raise money through bonds. Governments "sell" debt and they do it by issuing bonds.

Government bonds are a way for individuals, organizations, businesses and even other countries to give loans to each other. Government bonds are issued by the individual governments of the world and are a promise to pay you back, plus a small fee, at a set date in the future. US bonds are widely considered to be the safest bonds in the world: US bonds are also referred to as a "safe haven" investment. A default by the US could be a catastrophic event for the world markets since much of the worlds economy and financial systems are based on the US dollar and the US's ability to pay its debts.

The United States has run a deficit in all but four years since 1970. The deficit is the amount of financial short fall in a given budgetary year. Each year the deficit adds up; the total national debt is currently over $17 trillion dollars. In the early part of the current century the National Deficit ran at about a half trillion, this increased to over $1 trillion in 2008. The deficit has run at over $1 trillion dollars over the last few years and is one of the major sticking points between the Democratic and Republican parties. At one time the US Government spent nearly 1.5 times the amount in brought in through tax revenue.

Total government debt is more than just the cumulative amount of yearly deficits. There is also interest to take into account. The US government finances the budget deficit through sale of its debt through bonds. These bonds are held publicly and privately, by individuals, companies and other countries. The US must pay interest to these bond holders and that interest is added and included in the total debt.

The Federal Reserve Bank Buys Bonds

The Federal Reserve Bank has been buying $45 billion in bonds each month through Operation Twist and other, more substantive, QE programs.
The Federal Reserve Bank has been buying $45 billion in bonds each month through Operation Twist and other, more substantive, QE programs. | Source

Federal Reserve Bank And The National Debt

The Federal Reserve Bank is a collection of 12 banking districts that compromise the central banking system of the United States. These banks enact monetary policy as set forth by the Federal Open Market Committee. The Committee is headed by a chairman who is appointed by the President. The Federal Reserve holds the cash and investments of the United States. The Reserve gives money to the Treasury on a regular basis in order for the government to pay its bills. All money that is taken in taxes or through bond offerings is held by the Federal Reserve Bank. The FOMC and The Federal Reserve are also responsible to some extent for the state of the US economy, especially interest rates.

Following the 2008 financial crisis the Federal Reserve Bank and the FOMC began a long series of economic stimulus activities that are collectively called QE. This has ranged from QE1 to QE3 and other actions like Operation Twist. One specific example is the purchase of US Government Bonds. The Federal Reserve has been spending $45 billion each month in order to support long term interest rates. This is good for the economy now but does raise some long term red flags; The US Government is selling debt to itself. The quantitative easing policies of the United States and other countries is a potential house of cards.

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Ponesa 23 months ago

Amazing post and very interesting stuff you got here! I deineitfly learned a lot from reading through some of your earlier posts as well and decided to drop a comment on this one!

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