The latest twists in the seemingly endless saga of the U.S. debt ceiling underscore once again how strange the whole thing is.
The very existence of the debt ceiling is utterly superfluous. Every couple of years members of Congress have to vote to allow borrowing to fund measures that they’ve already approved through individual spending bills. Its main function is political: Whichever party isn’t in power at the time uses it to try to either extract something from, or embarrass, the other side.
On top of that, the limit isn’t really the limit. By invoking the vague catchall of “extraordinary measures,” Uncle Sam can keep on borrowing even after it’s hit the cap—or when the limit has been reinstated following a suspension, as was the case at the end of last month. Given that the alternative is either what’s known as a technical default or a seizing up of everyday government spending, that’s a good thing, even if you’re a fiscal hawk, which is an endangered species these days.
Just because something is mainly theatrical, though, that doesn’t mean it can’t have an impact. This month marks the 10th anniversary of S&P’s decision to strip America of its AAA credit rating, a move that followed one of many bruising Congressional fights over the debt limit. The move by the ratings agency back then sent a shiver through markets and caused a lot of consternation from Wall Street to Washington. But the U.S. has continued to borrow cheaply—indeed, even more cheaply than before.
Right now, the ceiling is at about $28.4 trillion, and the U.S. Treasury’s fancy footwork on accounting should keep U.S. borrowing authority officially intact for a little while. That should allow lawmakers to stitch together enough votes for either an increase or another suspension in the coming months. But what if they don’t?
One subplot of the drama helps put some perspective on this question. With the overall cap for debt back in force as of the start of August, the Treasury has been forced to slash its cash pile—essentially the balance of the government’s main checking account—to around the same level it occupied before the last ceiling suspension. The legislation that governs the ceiling includes a measure to hold things in check; without it, there’d be little to restrain the government from simply issuing tons of debt, while the now-lapsed suspension was still in place, in order to be able to spend the money later.
For quite a long time, some market observers have acted on the assumption that this time around, the cash pile would end up somewhere in the vicinity of $130 billion. In May, though, the Treasury itself said its borrowing plans were premised on the pile amounting to around $450 billion.
Ultimately, the Treasury got down to within around $10 billion of that, which the market appears to accept as close enough. Would it have made much of a difference if they were off by $50 billion or $100 billion—or $500 billion? Would there be any real penalty beyond a bit of political scoring in the never-ending ceiling tussle?
This isn’t a moot point. In its quest to get the cash balance down, the Treasury has affected markets. It has been dialing back its borrowing in T-bills—its shortest-maturity securities—and that, in turn, has been distorting money markets and complicating the Federal Reserve’s management of interest rates.
The issue is that when there’s a shortage of T-bills, they become more expensive, and the yield they offer falls. And because the kinds of people who buy T-bills also invest in a range of other money market instruments, the rates on those come under pressure, too.
That’s not necessarily a concern until it starts pushing the rates on which the Federal Reserve focuses out of its target band. At that point, the Fed needs to pull some other levers. Such a response carries costs while continuing the cycle of distortion.
A further example: On occasion, the imminent approach of a so-called technical default by the world’s largest debtor nation has prompted odd moves in various T-bills as those securities that are most at risk of non-payment become market pariahs. While this is most acutely a problem for investors in those individual issues, it throws out of kilter a market that helps benchmark a huge swath of the world’s borrowing—both government and private.
Nobody can honestly pretend that the ceiling is a mechanism to rein in debt. It causes distortions, and it wastes a lot of time and energy that the denizens of Washington could devote to ensuring the money being borrowed is spent effectively and productively. That’s not to say that debt and deficits don’t matter. But the way the U.S. thinks and legislates on the topic needs to change. —With Alex Harris
By: Benjamin Purvis