Debate over raising the debt ceiling is ‘simply crazy talk’

As if there isn’t enough to worry about, the political drama over the Treasury debt limit is suddenly heating up. The debt limit caps the amount of money the U.S. government can borrow and has been around more than 100 years. The limit seems to be a problem every couple of years because the federal government typically runs a budget deficit — it spends more than it collects in revenues — and must issue more debt to raise the cash to pay all its bills.

If lawmakers fail to increase the debt limit and the government is unable to borrow more, the government will quickly run out of cash, and some lenders will not get paid on time. That would be catastrophic. A bedrock of the global financial system and our economy is that the U.S. government pays its bills on time.

This has been so since America’s founding, and it has brought us enormous economic benefits. Particularly when times are tough (and goodness knows there are plenty of tough times), global money comes pouring into the U.S., cushioning any blows to our economy. That’s because investors worldwide know U.S. Treasury bonds are a safe investment. Investors get their money back with interest and on time.

Any debate over increasing the debt limit is thus simply crazy talk. Not doing so and causing the government to fail to meet all its financial obligations will upend investor confidence and put a stake in the heart of our economy.

The taxes U.S. workers paid this April are coming in weaker than expected, and the so-called X date — when the Treasury runs out of the cash needed to pay the government’s bills on time — could hit as soon as early June. Time is running out for lawmakers to increase or suspend the debt limit.

Global investors are suddenly focusing on the possibility that lawmakers won’t act. The cost of buying insurance in case the Treasury fails to pay its debt on time has jumped in recent weeks. It is already much higher than in 2011, when that unnerving debt limit drama caused rating agency Standard & Poor’s to strip the United States of its AAA rating.

Another indication of investor angst is the recent plunge in the interest rate on 1-month Treasury bills. Investors are purchasing these securities knowing the Treasury has enough cash to pay its bills at least for the next month. After that, given the early-June X date, investors aren’t 100% certain. Interest rates on 3-month Treasury bills are rising as investors attach nonzero odds that the debt limit drama will end with a default this summer.

House Republicans passed legislation to address the debt limit, the “Limit, Save, Grow Act of 2023,” this week. It comes just in time.

This legislation would increase the debt limit enough to push the next debt limit battle to this time next year. In exchange, it would cut future discretionary government spending; impose stricter work requirements on low-income households receiving health care, food, and other assistance; and roll back much of the Biden’s administration’s agenda on climate change and student lending.

House Republicans hope the legislation will put political pressure on President Joe Biden to negotiate changes in fiscal policy in exchange for an increase in the debt limit.

The president continues to reject these efforts, arguing for a “clean” debt limit increase — an increase in the debt limit without substantive changes to policy. His position is that increasing the debt limit is necessary to pay the government’s bills resulting from past tax and spending decisions, over which there can be no negotiation.

I’m not a fan of the House Republicans’ plan for a host of reasons. Most immediately, it puts the economy at risk. Recession is already a serious threat, with a consensus of economists and many investors and business executives expecting an economic downturn beginning late this year or early next, though my own view is less gloomy.

Adding government spending cuts to the headwinds the economy already faces would meaningfully increase the likelihood of a downturn.

The legislation will also push this debate to a year from now, which would make it part of the 2024 presidential campaign discourse. That may well make the next debt limit drama even more heated than the current one. This will weigh on already fragile investor, business, and consumer confidence and economic activity.

Lawmakers will likely kick the can. It’s a stretch to think they can come to terms by early June. Instead, they will suspend the debt limit long enough to line the X date up with the end of the current fiscal year at the end of September. This will buy time and combine the debt limit decision with the government’s fiscal 2024 budget — also must-do legislation for lawmakers to ensure the government is funded and avoids a shutdown.

Getting this across the finish line into law will surely be messy and painful to watch. Stock prices will fall, borrowing costs for businesses and households will rise, and the value of the U.S. dollar will struggle. Unfortunately, this is likely what’s required for investors and political donors to demand lawmakers put an end to the drama and agree to legislation to avoid a government shutdown and a breach of the debt limit.

But that legislation will undoubtedly be anticlimactic, allowing both House Republicans and Biden to declare political victory but accomplishing nothing. Of course, this outcome is more or less the same as all the debt limit battles we’ve suffered over the past century: lots of drama, frazzled markets, worried businesses and households, but no progress addressing our daunting long-term fiscal challenges.

Mark Zandi is chief economist for Moody’s Analytics.