Making sense of the debt ceiling debate

The debt ceiling debate has gripped the nation so much that we have focused on the political game of brinksmanship and lost focus on the two basic questions underlying the debate. First, what will happen if the debt ceiling is not raised? Second, is the nation’s level of debt too high? Let’s look at the data.

The answer to the first question is…we don’t know. We have never been here before. Oh, we have approached the debt ceiling many times, but raising it was never in question…until now.

Will we default? Not likely, because the Constitution demands that we don’t. If all proposed deals to reduce spending as a condition to raise the debt ceiling fail, Congress will likely pass a one-sentence bill to raise it. For how long and by how much is unknown. The markets seem to maintain confidence that the debt ceiling will be raised.

If Congress doesn’t raise it, will we default? Yes, and the market consequences would be dire. The 3 rating agencies would likely downgrade the nation’s sovereign credit rating. Such a downgrade would raise interest rates on US Treasury securities, creating major losses in the market.

If they don’t raise it, can the US pay its bills? No. According to the Bipartisan Policy Center, the Treasury is expected to run out of cash around August 2nd.  For the rest of August, the government is expected to collect $172.4 billion in revenues and must pay $306.7 billion in obligations. This leaves a $132.4 billion gap (just for August) that would normally be covered through borrowing. In August, about $500 billion in Treasury securities will mature, and while usually these are simply “rolled over” (borrow by selling new securities to pay the principal and interest on the maturing securities), the present debt limit would prevent this. Other big obligations in August include $50 billion in Medicare/Medicaid payments, $49 billion in Social Security payments, $32 billion in payments to Department of Defense vendors, $20 billion in Department of Education payments, $17 billion in federal employee salaries and benefits (including active duty military), and $13 billion in unemployment insurance payments, among others.

The answer to the second question is…yes, the debt level is at an historically high level, comparable only to levels in response to the Great Depression.

Take a look at the graph below.  It charts real Gross Domestic Product (GDP, blue line measured by left vertical axis) against gross debt as a percent of GDP (red line measured by right vertical axis). Let’s look at real GDP first. It almost always increases, even after controlling for inflation. Real GDP has had one-year decreases 6 times since 1940: in 1946 (by $122 billion), 1958 (by $25 billion), 1975 ($90 billion), 1982 ($77 billion), 1991 ($28 billion), and 2009 ($442 billion). Yes, this recent economic emergency was a big one!

Real GDP and Debt as Percent of GDP

Now look at the debt as a percentage of GDP. It was at its highest in 1946 at 122% of GDP. In fact, debt more than doubled in 4 years (from 55% in 1942 to 1946) as a share of GDP. This was the nation’s response to get out of the Great Depression. Compare that crisis to the most recent one. Now, debt is 103% of GDP, up 59% as a share of GDP since 2007 when the crisis began 4 years ago. The two economic crises are similar, and so are the responses.

In conclusion, not raising the debt ceiling would wreak havoc on our economy, and our level of debt is at historic levels. However, we’ve been here before, and we made it out just fine.


Author: Dr. Lloyd Blanchard, Director of Public Performance Management