I am getting this question from quite a few people I talk to these days so I figured I’d just write a quick blurb on it. What is the debt ceiling and why does it matter?
1) The United States has run budget deficits for most of its existence. This means the country spends more than it taxes and so it sells bonds to cover the difference. This debt they sell contributes to the overall national debt.
2) In 1917 the US government imposed a “debt ceiling”. The debt ceiling is a restrictive limit on the amount of debt the US government can have in total. So, if the US government adds $10 in debt in year 1 and then they implement a debt ceiling of $19 for year two then the national debt can’t expand by more than $9 in year two without raising the debt ceiling.
3) Going over the debt ceiling would mean the US government legally can’t pay its bills and would default on the national debt. This would be catastrophic in ways that would make Lehman Bros look like a walk in the park.
4) What’s strange about the debt ceiling is that it is not really a constraint on the size of the deficit. That is, spending is appropriated BEFORE the fact and causes the debt levels to approach and perhaps breach the debt ceiling AFTER the fact. I’ve compared the debt ceiling to eating a pizza and then tying your small intestine in a knot and threatening your stomach not to digest the pizza. It seems like a rather silly way to go on a diet, right? Anyhow, the government has untied the knot (raised the limit) 78 times since the debt ceiling was implemented.
5) The USA is one of a handful of countries with such a limit. Almost every other country in the world relies on the standard political debate process to agree on the proper size of government spending and taxation.
6) The merit of the debt ceiling is hotly debated. Is it a useful way to try to control government spending and spark debate? I guess there’s some merit to that position, but I personally wish there was a more intelligent and thoughtful way to go about having these discussions without playing Russian Roulette with the credit of the US government once every few years. Holding ourselves hostage under this self imposed rule shouldn’t be a necessary part of the political process and it’s a rather dangerous way to get things done. After all, if we have to default on ourselves in order to cut spending then something much bigger is broken than the levels of government spending….
Mr. Roche is the Founder and Chief Investment Officer of Discipline Funds.Discipline Funds is a low fee financial advisory firm with a focus on helping people be more disciplined with their finances.
He is also the author of Pragmatic Capitalism: What Every Investor Needs to Understand About Money and Finance, Understanding the Modern Monetary System and Understanding Modern Portfolio Construction.