Hitting the Debt Ceiling: Why its a Big Deal

Treasury Secretary Geithner sent a special letter to every member of Congress today warning them that the U.S. could reach its debt limit as early as March 31st of this year. He said that if lawmakers fail to raise the debt limit, it could “precipitate a default by the United States.” As of today, the national debt stands at $14.01 trillion and growing, which is not far from the current debt ceiling of $14.3 trillion.

The Gross National Debt

The debt ceiling is a cap that Congress sets on the amount of debt that the government can borrow. Although the debt limit has been raised 10 times since 2001, the debt ceiling is important because it helps Congress control spending. Each time the debt ceiling is raised, lawmakers are forced to actively assess the state of U.S. fiscal finances. If the debt ceiling is reached (and it never has been), the Treasury would not legally be permitted to borrow additional money.

The reason why this could “precipitate a default” according to Geithner is because the U.S. government funds operations and pays its creditors by borrowing. If they are unable to borrow, they are unable to make up the difference between what they spend and what they take in and if left unresolved this could lead to a default. Even a hint of default risk could cause rating agencies to downgrade their outlook for U.S. debt which would be enough to cause the dollar to nose-dive. For this reason, Geithner’s warning should not be taken lightly.

4 Comments

  1. Thanks Kathy, I had not seen this and it will no doubt add weight to higher bond yields in the short term. The interesting thing about higher bond yields is that they almost always correlate with a higher USD. At the moment there has been a breakdown between the interest rate differentials and USD/JPY, I for one like the USD/JPY well higher than current levels and think that a reasonably sharp move up towards 87.00 is on the cards. At anyrate, great blog and keep it up!

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  2. I think this is USD/JPY positive for the moment, if it doesn’t get “too bad”, yields are rising, isn’t it? somebody comment?

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  3. You would think the with the “need” to raise the debt ceiling year after year, someone would say, perhaps we should figure out a way to reverse this unsustainable trend.

    At this point, I’d say it might need to be raised again, but only on the condition that something is done about the spending. The US government should have been looking at this 3 years ago, or earlier.

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