U.S. To Hit Debt Ceiling Later This Year

FORECASTS & TRENDS E-LETTER
by Gary D. Halbert
January 17, 2023

IN THIS ISSUE:

1. Another Debt Ceiling Battle Later This Year

2. Inflation Continues To Fall, But Not Enough

3. Why Do We Even Have A Debt Ceiling Anymore?

4. Why Not Abolish The Debt Ceiling Altogether?

Overview: Another Debt Ceiling Battle Later This Year

The US will reach the current debt ceiling of $31.4 trillion this year, possibly before the end of this month and maybe even later this week, depending on how federal revenues come in. Once the debt ceiling is reached, the Treasury Department will employ so-called “extraordinary measures” which allow the government to pay its bills for several more months.

As you know, raising the debt ceiling is always a political circus, and this year looks to be no exception, especially now that the Republicans control the House of Representatives where all spending bills originate.

These fights over raising the debt ceiling are almost always bad for the financial markets because of the increased uncertainty they create. You know the story: if the US were to default on its debt, all hell would break loose.

But of course we all know that’s not going to happen. The political clowns in Washington always stop fighting just in time to avoid a debt default. Which raises the question: Why do we even have a debt ceiling anymore?

Today, I will argue that we should get rid of the debt ceiling since it does nothing to keep our national debt under control. I’ll explain why the debt ceiling came to be in the first place and why it has morphed into such a political football in recent decades. I think you’ll find it interesting.

Before I get to that discussion, let’s take a brief look at last week’s Consumer Price Index report which showed inflation slowing for the sixth consecutive month. That’s the good news. The bad news is inflation is still far above the Fed’s 2% target, which virtually assures more interest rate hikes in the months ahead. And rates could remain high for longer than most people expect. Let’s get started.

Inflation Continues To Fall, But Not Enough

Last Thursday the Labor Department reported that its Consumer Price Index (CPI) edged lower in December by 0.1%, the sixth consecutive monthly decline. For the 12 months ended December, the CPI jumped at an annual rate of 6.5%. While 6.5% is well below the peak of 9.1% last year, it is still substantially above the Fed’s target of 2%.

As noted above, the good news is inflation is clearly trending lower. The bad news is, it is not falling fast enough to satisfy the Fed, so more interest rate hikes look inevitable in the weeks and months ahead.

Most Fed-watchers would like to believe the Fed will raise rates a couple more times, then pause around mid-year and begin to lower rates again in the second half of this year. That scenario, however, appears overly optimistic. Here’s why. At the latest Fed Open Market Committee (FOMC) meeting, not one of the 12 FOMC members estimated that the Fed Funds rate would begin to fall before the end of this year. This is not good if you’re bullish!

Why Do We Even Have A Debt Ceiling Anymore?

For decades I argued passionately in these pages that the federal government should balance its budget, live within its means and stop increasing the national debt. But we all know those days are over, sadly. It doesn’t matter which political party is in power, the federal budget goes up every year and the debt gets larger and larger.

This won’t end until America’s creditors fear they may never be repaid and stop buying our Treasury securities. Who knows when that will be?

What we do know is that measures intended to control US debt – such as the debt ceiling – do not work, and we probably should just get rid of it. The ongoing fights to increase the debt ceiling are totally unnecessary because we always raise it, no matter what.

So why do we even have a debt ceiling in the first place? The debt ceiling was first created in 1917 to help the government fund World War I by grouping bonds into different categories, easing the burden on Congress to approve each bond separately. Why they called it the “debt ceiling” I do not know.

With World War II looming in 1939, Congress changed how the debt ceiling was defined and gave the Treasury Department wide latitude on what types of bonds it could issue.

The debt ceiling was routinely raised without incident until 1953. That year, approval was held up in the Senate in an attempt to restrain President Dwight Eisenhower who had requested a big increase in federal debt to enable construction of the national highway system.

Debt Ceiling Becomes A Partisan Political Weapon

The debt limit has since been raised dozens of times, usually without a fight. But the past quarter century has seen the debt ceiling increasingly become a partisan weapon.

Raising the debt ceiling was among the main disputes that caused two shutdowns of the federal government in late 1995 and early 1996. Another fight occurred in 2011, rattling financial markets and prompting Standard & Poor’s to issue the first-ever downgrade of the US government’s credit rating.

The federal current debt limit of nearly $31.4 trillion is expected to be reached sometime in 2023, possibly as early as this week. Earlier the Treasury Department estimated we wouldn’t reach the limit until September, but now it is expected to be sooner. Why is that?

As one example, when President Biden announced plans to forgive some student loan debt and delay payments on other portions of it, that meant less revenue to the government – which means we will reach the debt ceiling even sooner than previously expected.

Treasury Secretary Janet Yellen has urged Congress to extend the debt limit through the November 2024 presidential election to head off the risk of a catastrophic default.

When the government hits the debt limit, Yellen will be able to stave off default by a few months by employing a toolbox of so-called “extraordinary measures,” such as withholding regularly scheduled contributions to a federal employee retirement fund and using that money to keep paying debts, among other options.

But once those extraordinary measures are exhausted, the options get more dire, potentially leading to a partial government shutdown and delays in government payments like Social Security checks.

Leaders of both political parties acknowledge that the debt limit must be raised, because the gap between government spending and revenue is so large. But many Republicans, who now control the House of Representatives, want to pair a debt limit hike with spending cuts.

Both parties agreed to debt limit hikes under Republican President Donald Trump without much of a fuss. But Republicans blame the current high inflation on spending increases during Biden’s first two years in office, and some, including House Republican Leader Kevin McCarthy, see the debt limit as a key leverage point.

Why Not Abolish The Debt Ceiling Altogether?

Some budget experts and commentators want to abolish the debt ceiling, arguing that the periodic congressional battles over it increase economic uncertainty and disrupt markets, even if only temporarily. Supporters of the limit say using it to bargain for spending cuts serves the public interest at a time of historically high debt levels.

The Obama administration considered but rejected untested ways to circumvent the debt limit, including minting platinum coins and placing them in the Federal Reserve and at one point declaring the debt limit a violation of the 14th Amendment prohibition on questioning federal debt.

In recent decades, the debt ceiling debate has devolved into little more than political theater. It encourages lawmakers to engage in brinkmanship in the name of fiscal responsibility – though past showdowns have done nothing to meaningfully alter the long-term rise in federal debt.

House Republican leaders liken the debt ceiling to a credit card limit, promising to put “mechanisms in place so that you don’t keep maxing it out,” in the words of House Majority Leader Steve Scalise of Louisiana. But then they max it out anyway.

The Republicans used to be the party of smaller government and balancing the budget. But those days are gone – the Republicans have proven they can spend with the best of them.

In conclusion, while the current debt ceiling of $31.4 trillion will surely be increased later this year, Congress should think seriously about abolishing it altogether. It serves no purpose any more, so why continue to have these political fights every year or two which upset the financial markets and make US creditors uncomfortable.

So when it comes time to increase the limit this year, I would hope some in Congress would also introduce legislation to permanently eliminate the debt ceiling. I find it ironic that I would argue for this position since I have complained about federal deficit spending for over 40 years. But the debt ceiling clearly doesn’t work, and lawmakers on both sides of the aisle have demonstrated they have no regard whatsoever to the size of our national debt.

As suggested above, our debt will continue to grow so long as creditors are willing to buy our debt instruments. I suspect it will take some kind of financial crisis to cause creditors to stop buying our debt.

What kind of financial crisis that might be, what will cause it and when it might occur are uncertain, but history says it will happen at some point. It has always happened to nations that spend far beyond their means. I don’t expect the US to be the exception.

Very best regards,

Gary D. Halbert

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