What if the US could not pay off its debts? Will the citizens of world most powerful country and the biggest economy be confident enough that their government will take case of its interests first? Are they sure of it? Will the citizens be the first priority?
First let us see what a debt limit is and what will happen if the government exceeds that limit. Debt limit is the amount of money the government is allowed to borrow pay off its debt. A government has a lot of bills to pay like social security, pay and allowances, government expenditures, medical bills, interest on previous debts and many more. When the revenue coming from the taxes and investments do not cover the expenses and what it owes domestically and internationally then it needs to borrow from the treasury, the same goes with all countries.
You might be thinking that if you cannot pay off your debt, and you take one debt to pay off another debt then you will be in thick soup and will be bankrupt or even might land up in jail. But the US is doing the same for the last 100 years and still seems to be doing fine till now. The last time the US govt raised its debt limit was in 2019 and now it is just about 22 trillion.
The debt limit is different from the budget. Budget is the plan as to how much the government wants to spend each year. Debt limit is the maximum that the government can borrow to pay off its existing bills. So raising the budget impacts debt limit but raising the debt limit does not increase government spending. Debt limit is the money that the government can borrow to meet its financial obligations.
When did it start? It started in 1917 when US was in the First World War. It required money for the war so the treasury allowed the govt to issue war bonds. As the government had to pay back the money with interest so the first debt limit was set at 11.5 billion. Now it is about 22 trillion. So what would happen if the US govt is not able to pay its bills- a hypothetical situation as of now?
In the beginning it may seem ok, but things can change very fast. The government will absolutely not like to hit this limit so it will take measures to curtail expenses. The treasury would step in when the government approaches very near to the debt limit and would initiates extraordinary measures. The easiest way for the government will be to stop reinvesting its govt funds. The govt sets up funds such as govt transactions, retirement funds, currency exchange and puts its money in it. It then invests some of it in treasury securities. This way it makes some interest on those funds. This is done on daily basis. But as an extraordinary measure it can stop doing this so that it has cash in its hand. This will give the govt access to an immediate pool of money but will stop the growth of the funds it covers.
Other measure can be stopping or pausing pension funds, pausing government securities and borrowing money from other funds. When the debt limit is reached, it means it can no longer borrow from the treasury as the treasury in itself has run out of cash. Now the govt has to decide on which bill to pay and which bills to postpone paying. It needs to prioritize its expenditure. The expenditure on social welfare measures like social security, pension, and healthcare may not be the first priority of the govt then. The govt may decide to pay off the interest it owes to the treasury first than expending on social welfare plans. It will be a dire situation when the world will see that a country is not able to pay back to the treasury and other countries and will have serious economic ramifications. In that case people will lose faith in the govt and interest rates on all types of loans will go up which will lead to recession and may lead to depression as that of the 1930’s.
We do not think much of the debt limit but only about the budget as this only affects us. Debt limit is something which is managed by the finance ministry and the treasury of a country. So a lot can go in the background which the average person is not privy to and has little understanding of it. Around the world there are countries which have faced similar situations. Even the Chinese aggressive policy is pushing some countries in Africa towards reaching the debt limit.
Thank you Telesfor sir