Published on: 09/15/2023
The National Debt Ceiling Explained
If you pay any amount of attention to the markets or the news in general, you almost certainly know that the national debt ceiling has been cause for concern for politicians, investors, and everyday people alike. But amidst the 24/7 news chatter, the myriad issues surrounding the national debt ceiling are often obscured by noise and speculation.
Before anyone can make sense of the national debt ceiling, it’s crucial to first understand that the government debt ceiling is not about new spending. Instead, it pertains to the U.S. government’s ability to fulfill obligations it has already committed to, including Social Security and Medicare benefits, military salaries, interest on the national debt, and tax refunds.
To have the concept of debt ceiling explained in simpler terms, it is essentially a cap on how much the federal government can legally owe — as set by the U.S. Congress —-to its citizens (via public debt) and to itself (through intragovernmental debt).
What is the U.S. debt ceiling?
As mentioned, the U.S. debt ceiling is a statutory limit imposed by Congress on the total amount of money that the federal government can borrow to meet its existing legal obligations. After looming debt ceiling concerns, the current administration suspended the debt limit until December 2025. As of 2023, that limit is set at $31.4 trillion.
When the U.S. debt ceiling is reached, Congress must increase the debt limit in order for the government to continue borrowing and meet its current obligations. If Congress fails to raise the debt ceiling or decides not to increase it, the Treasury might have to take steps like suspending certain payments and issuing IOUs to ensure its obligations are met.
The debt ceiling is not the same thing as the national budget, which involves setting spending levels for different government programs. It is simply a limit on how much the US government can borrow to fulfill its existing commitments.
Who does the US borrow money from?
The U.S. debt is made up of two main components: public debt and intragovernmental debt.
Public debt consists of the money borrowed by the Treasury from external entities, such as foreign governments, institutions, and individuals. Treasury bonds, notes, and Treasury inflation-protected securities are all examples of ways the government borrows money from the U.S. people.
In contrast, intragovernmental debt consists of money borrowed by the government from itself. This is mainly made up of trust funds — such as Social Security and Medicare — which have been financed using revenues collected by the Treasury from outside sources. In other words, when Social Security collects more money than it needs to pay out benefits, the remainder is invested in Treasury Securities and used as a source of funding for other government activities.
Both types of debt are subject to the debt ceiling, meaning that any new borrowing must remain within this limit.
How is the U.S. Debt Ceiling Relevant?
So, what is the point of the debt ceiling? The U.S. debt ceiling is an important concept as it affects the government’s ability to pay its bills. When the debt limit is reached, the government has limited options for financing expenditures. In such situations, the Treasury Department must rely on “extraordinary measures” in order to remain within the legal borrowing limits.
When those extraordinary measures become exhausted and there are insufficient funds to manage day-to-day operations, Congress needs to approve an increase in the debt limit in order to avoid a default on payments.
In some cases, Congress may also make spending cuts or adjust existing tax provisions* as part of its negotiations. Ultimately, however, any decisions regarding the debt ceiling must be made with both fiscal responsibility and long-term economic planning considerations in mind.
*Continue reading: How much is tax in Texas?
How does increasing the debt limit affect the U.S. economy?
Increasing the debt limit allows the U.S. government to meet its current financial obligations. It provides short-term economic stability because if the limit is not increased and the government defaults, it can lead to severe economic consequences such as a rise in interest rates, a fall in the stock market, and a decrease in the nation’s creditworthiness.
Additionally, when the debt ceiling approaches its limit and there is indecision or delay in Congress regarding raising it, this can introduce uncertainty and potentially bearish vs bullish concerns into the market.
However, continually raising the debt limit without implementing fiscal reforms may cause long-term economic issues. It can lead to higher national debt, potentially causing inflation, and can crowd out private investment as more of the market’s available capital is consumed by government debt.
Therefore, while increasing the debt limit can provide immediate relief for government financing, it must be coupled with sound economic and budgetary measures to ensure asset protection and the long-term health of the U.S. economy.
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The debt ceiling can be explained as the legal limit set by the U.S. Congress on the total amount of national debt that can be issued by the Treasury. While there are pros and cons to increasing the government debt ceiling, it remains an important tool in ensuring the government has sufficient funds to cover its existing obligations. As such, understanding how this limit works is essential in order to make informed decisions regarding the economy.
The interplay between economics, politics, and finances is complex and constantly evolving. That’s why it’s essential to have a trusted partner by your side, guiding you through the intricacies of wealth management. At Avidian Wealth Solutions, we offer an array of financial services including managed accounts, alternative investment strategies, financial risk management, investment risk management strategies, and more — all tailored to meet your unique goals and objectives.
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