Yelling about the ceilings

Newsletter

Whichever way you swing politically, there is nothing to celebrate about the debt ceiling debate. Bad outcomes with bad processes demand reflection and behaviour change. Good outcomes produced with bad processes is even worse.


A couple weeks ago, with the collapse of SVB, people were yelling about fractional reserve banking. That's been mostly forgotten about, and the thing to yell about now is the US debt ceiling.

Just like fractional reserve banking, the debt ceiling is a fairly established part of the financial system.

Government's make money from taxes and other sources and use it to fund services for the people. Health and welfare and defence and whatever else is agreed upon in that year's annual budget. If that budget happens to cost more than the money the government makes, the result is a deficit which has to be funded from somewhere. There are a few options, raising taxes, printing money, but the most politically & economically palatable option is to issue new debt.

In 1917, during World War I, the government was spending a lot of borrowed money and the debt ceiling was established to place a cap on total debt.

The point is to give the US Congress - all the voting members of parliament which includes members from the ruling party and opposition - oversight on the government's spending. Congress must vote to approve raising the debt ceiling.

The thing is, Congress has already approved the debt, when the budget was approved. So, the debt ceiling is mostly just a formality. A formality with one big glaring unfortunate downside: if an agreement is not reached, the US Government could default on its debts.

And that's a really bad thing for the economy and for credibility. So bad that, in the 1970s a rule (called the Gephardt Rule after the Congressman who created it) was established that meant whenever Congress passed a budget resolution, it would automatically increase the debt ceiling by the amount necessary to finance the budget. Voila! No more risk of default.

Until 1995, when Congresspeople began waiving the Gephardt Rule for various agendas, again making the Treasury ask for approval to raise the debt ceiling to finance their approved spending.

Usually, after a bit of political back and forth, and some concessions made to appease the opposition, the debt ceiling is raised in good time to meet any payment obligations. In fact, there have been 78 approved changes to the debt ceiling since 1960.

But in 2011, things got ugly. The opposing party really was willing to let the US Government default unless they could agree on some pretty tall asks, including a budget deficit reduction with no tax hikes (meaning either cut spending on government services, or print more money).

This political back and forth ultimately ended 2 days before the Treasury was due to default, and less than a week later, the US' credit rating reduced from AAA (squeaky clean) to AA+ (very low risk), where it remains.

This happened again in 2013, and it seems we're back here today:

Whichever way you swing politically, there is nothing to celebrate about this process. Bad outcomes with bad processes demand reflection and behaviour change. Good outcomes produced with bad processes is worse. It's gambling and winning.

For more on the debt ceiling, read 'What's our Problem?' by Tim Urban.