The U.S. officially hit the debt ceiling on Jan. 18, 2023. U.S. Treasury Secretary Janet Yellen says the Treasury is now taking extraordinary measures to avoid defaulting on the national debt.
Even with those measures, if Congress doesn't take action to avoid defaulting, the government will run out of money to pay what it owes this summer.
Here's a primer on the national debt, what happens if we default and why it's bad.
What Is the National Debt Limit?
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The national debt limit is essentially a cap, decided by lawmakers, on how much debt the U.S. government can have. As of Jan. 18, we reached that limit, which sits at a whopping $31.4 trillion dollars.
When Congress passes a spending bill, they decide what the government will spend its revenue on. That revenue comes mostly from taxes, but also from things like customs duties at the border and the sale of natural resources, according to the U.S. Treasury's Fiscal Data website.
Most of the time, the government doesn't have enough revenue on hand to pay for everything in those spending bills — such as infrastructure, social security, Medicare and defense. That's been the case since at least 2001, which was the last time the Treasury says more money was brought in than spent in a single year.
The gap between the revenue, and the things the government is spending it on, is the national deficit.
"We're spending more money, over a trillion dollars this year, than we're taking in," explained Greg Valliere, the Chief U.S. Policy Strategist for AGF Investments. "That gives us the deficit."
To make up the deficit and pay off debts, the Treasury sells securities, like bonds. The bond buyer gives the Treasury cash to pay the deficit, and in exchange the Treasury eventually pays the buyer back that money plus interest.
The debt limit caps how much debt the Treasury can take on to pay back the deficit incurred in previous years. As of Jan. 18, the Treasury has taken on the maximum $31.4 trillion in debt currently allowed — meaning we've hit the debt limit.
The debt limit amount is decided by Congress.
"The debt limit is a political issue, that both parties have used to their advantage, that requires Congress to raise the amount of debt we can have," Valliere said.
What Happens When We Hit the Debt Limit?
Hitting the debt limit isn't catastrophic. According to U.S. Treasury Secretary Janet Yellen, the U.S. has already reached that ceiling as of Jan. 18.
"I don't think today's number means anything," Valliere said. "I think it's more of a summer crisis."
Hitting the debt limit is like starting the final countdown clock for the government before the real disaster — a default — strikes. Now that the clock is ticking, the U.S. needs to either increase the amount of debt it can take on, or suspend the limit to that debt before it runs out of money.
Yellen said in her letter that the money could run out by June 5.
On Feb. 15, the Congressional Budget Office released its official projection for when the money will run out, estimating that the default could strike between July and September, depending on tax revenue the government brings in this April.
All of the $31.4 trillion included under the current debt limit is money the government has already spent on things like infrastructure, defense and so forth.
Once the debt limit is reached, the Treasury can't sell any more bonds and other securities to pay off the debt from previous deficits. Put simply: it can't get cash to pay off bills the government has already accumulated.
If the U.S. can't pay those bills, then it defaults on the national debt. This is where catastrophe strikes.
Why Is Defaulting Bad?
"[It's] in my opinion unthinkable to have the U.S. say 'We can't pay off our debt,'" Valliere said.
The Treasury would stop being able to pay out the federal money that goes to things like "Social Security and Medicare benefits, military salaries, interest on the national debt, tax refunds and other payments," according to a warning letter Yellen sent to Congress last week.
It would also stop the Treasury from paying back the money and interest that all those bond holders were promised when they made those purchases.
"I think it would be a signal to investors all around the world, including in the U.S... that the U.S. debt can't be counted on," Valliere said.
The U.S. credit rating "would almost certainly be downgraded," the White House said in a December 2021 post about the effects of a default, "and interest rates would broadly rise for many consumer loans, making products like auto loans and mortgages more expensive for families who are subject to interest rate changes or taking out new loans."
Higher interest rates due to downgraded U.S. credit would make it even harder for the Treasury to pay back the interest on future debt.
"In order to sell our debt, we're probably going to have to sell it at higher rates," Valliere said. "You'd have to offer higher rates to induce people to keep buying treasuries, because their risk will go up."
That would have a negative effect on the stock market. And with faith in the U.S. dollar tied to so many other pieces of the global market, those negative effects would be felt worldwide.
Why Have We Hit the Debt Limit Now?
Congress set the current $31.4 trillion debt limit back in December 2021, when Democratic majorities in both the House and the Senate voted to raise the debt limit by $2.5 trillion.
That vote came after another near-crisis after drawn out debate over spending, which ended just hours shy of the deadline set by Yellen.
"What's different this time I think is that you have an awful lot of very hardcore Republicans in the House, as we saw a couple of weeks ago," Valliere said, referring to the 15 votes that took place before House Speaker Kevin McCarthy got the gavel.
"And they are unwilling to agree to any increase in the debt ceiling unless there's an ironclad pledge to reduce spending."
The reason the debate over raising the debt limit is so arduous is because there's no ideal place for the government to tighten its belt and close the deficit to reduce that debt, Valliere explained.
"The problem is, people agree generally that we're spending too much money and deficits aren't good," said Valliere. "But when you get specific and you say, alright, so what would you do? Would you cut social security? Well, no, my God. Would you cut Medicare? No. Would you cut defense? Well, not dramatically... Would you have a big tax increase? No."
Without tax increases to citizens or corporations, cuts or curtails to government spending or a combination of both, the national debt will continue to rise to a new limit set by Congress. Then this cycle repeats.
Does the Debt Limit Stop U.S. Government Spending?
If the debt limit stayed where it is right now, the U.S. would still have $31.4 trillion of debt to pay, because that money has already been spent and needs to be paid back.
The amount the government continues to spend on things it needs, like infrastructure, defense, and social security, is only determined by future spending deals. That's a related, but different, political debate.
Theoretically, the debt limit is a tool to keep government spending from expanding unchecked.
If there's a ceiling on how much debt the U.S. Treasury can take on by issuing securities, then the government can't keep widening the deficit when it decides how much to spend.
But how to increase revenue — the amount of money the government is bringing in — is where Republicans and Democrats tend to disagree. Very generally, Republicans prefer to cut spending while Democrats find ways to raise more money through taxes.
Even if Congress authorizes an increase to the debt limit, the political negotiations required to get there could lead to some kind of budgeting compromise between the two very opposed parties.
According to Valliere, that logic still holds some weight.
"Previous deals have usually been accompanied by some fiscal restraint," he said. "As painful as this exercise will be, I think it almost certainly will [result] in less spending... Or, to be accurate in the phraseology, it's not like we're going to cut defense. We're going to slow the rate of increase."
How Can the U.S. Government Avoid Defaulting on the National Debt?
The U.S. has never defaulted on the national debt before. The dollar has also only ever been downgraded once in U.S. history. That happened in 2011, when a different political stalemate over raising the debt limit lasted too long, against a backdrop of slowing economic growth.
It's too early to say how long the 2023 debate will last, if it will end in default, or if the gridlock will lead to another U.S. credit downgrade. It's also hard to predict what will happen to the economy in the lead-up to this summer.
"The market is very humbling and nobody gets it right all the time," Valliere said. "I use the word volatility.... I think that [a long debate] does make it quite likely that we're into a period of great volatility for the next few months."
At this point, the only way to avoid a default on the national debt is for Congress to vote to raise the debt limit above $31.4 trillion, or to vote to suspend the debt limit entirely.
To keep the government running after the debt limit was reached, the Treasury is taking "extraordinary measures." That means the treasury is shifting money around to find extra cash.
Those special measures, which Yellen has begun using, include selling off the investments the Treasury has put into pension and health funds for some retired federal employees, and then re-investing the money when the debt crisis has passed and the Treasury gets some cash back.
The Treasury can also stop investing money back into things like the Exchange Stabilization Fund —a pool of money the Treasurer can control the use of without quite so much Congressional oversight —and use that cash to pay debts. Yellen has not yet stated she's using this special measure, but it's been done before by other treasury secretaries.
"The Treasury Department, Janet Yellen and her people, are confident they can shift funds from one account to another, do some creative accounting and probably keep the government open" until the summer, Valliere said.
Even so, because of the unpredictable political power balance, it's hard to say if or when Congress will reach a deal on the debt limit.
"I've been writing to my clients in the last few weeks," Valliere said. "I've said there's a 60-40 chance that there will be a deal at the last minute. But you know, that means there's a 40% chance we could default. And that's, that's a little too close for comfort."