Throughout modern history, the U.S. has never defaulted on its debt. The government has a self-imposed borrowing limit known as the debt ceiling, and over time, it has raised or suspended that limit to help prevent the U.S. from defaulting on its debt.
Key Takeaways
- In modern history, the U.S. has never defaulted on its debt.
- The debt ceiling is the self-imposed limit on how much debt Congress allows the federal government to have.
- If Congress does not raise or suspend the debt ceiling, the U.S. could default on its debt, which would also impact financial markets and the economy.
Recent Debt Ceiling History
The debt ceiling was reached again on Jan. 19, 2023, when the national debt crept above $31.4 trillion. It was set in December, 2021, when the debt ceiling was raised by $2.5 trillion. Until Congress increases the debt limit, the Treasury Department must rely on "extraordinary measures" to meet the government's obligations. These measures cannot go on indefinitely, and the government will be at risk of default sometime later this year.
The last time the debt ceiling was hit was Aug. 1, 2021; that limit was $28.4 trillion. If the ceiling hadn't been raised or suspended, the Treasury Department would not have been be able to issue more Treasury bonds, which bring in revenue to help pay bills. The government would be forced to choose between paying federal employee salaries, Social Security benefits, or the interest on the national debt. If it doesn't pay that interest, the country would default.
Two Ways the U.S. Could Default on Its Debt
There are two ways the U.S. could default on its debt: not raising or suspending the debt ceiling and not paying interest on Treasury bills, notes, and bonds.
Failing To Raise or Suspend the Debt Ceiling
The U.S. could default on its debt if Congress doesn't raise the debt ceiling once it’s reached. Congress also has the power to suspend the debt limit, as it did in 2019 with the Bipartisan Budget Act.
When the debt ceiling is reached, the Treasury Department takes various emergency financial measures to help pay the nation’s bills, buying some time for Congress to make a decision on the debt ceiling. However, those measures can only last so long.
In a statement on Oct. 6, 2021, during the last debt ceiling crisis, Treasury Secretary Janet Yellen stressed the urgency of raising or suspending the debt ceiling as a way to prevent default.
“Treasury is on the cusp of exhausting its extraordinary measures if Congress has not acted to raise or suspend the debt limit,” Yellen said. “After that point, we expect Treasury would be left with very limited cash that would be depleted quickly.”
When a decision on raising or suspending the debt ceiling is delayed, businesses and consumers often lose confidence in the nation, which could lead to higher interest rates, uncertainty in the financial markets, and a downgrade of the U.S. credit rating.
U.S. debt has been seen worldwide as a safe investment. Most investors look at Treasurys as if they were 100% guaranteed by the U.S. government. Any threat of default could cause debt rating agencies, such as Moody's and , to lower the U.S. credit rating, and that could impact the stock market. For example, in April 2011, the S&P only lowered its outlook on the U.S. debt from AAA (extremely strong) to AA+ (very strong), yet the Dow Jones Industrial Average immediately dropped 140 points.
Not Paying Interest on Treasury Bonds
The second way the U.S. could default on its debt is if the government simply decided that its debt was too high and it stopped paying interest on Treasury bills, notes, and bonds. In that case, the value of Treasurys on the secondary market would plummet.
Anyone trying to sell a Treasury would have to sell it as a deep discount. The federal government could no longer sell Treasurys in its auctions, either, so the government would no longer be able to borrow money from investors to pay its bills.
How a U.S. Debt Default Could Impact the Economy
A U.S. debt default is much more than the federal government simply not paying its debt. It would greatly impact the economy and people in the U.S:
- A default would increase interest rates, which would then increase prices and contribute to inflation.
- The stock market would also suffer, as U.S. investments would not be seen as safe as they once were, especially if the U.S. credit rating was downgraded.
- Several government programs like Social Security and Medicare would be impacted, too. Military wages and even small business owners with federal loans would be at risk in the event of a default. Federal employees wouldn’t be paid and parents expecting a Child Tax Credit payment would get nothing.
These financial impacts would have a major effect on consumer spending and businesses could shut down. Eventually, the U.S. could enter another recession as a result.
Note
Other nations have defaulted (or narrowly escaped default) on their debt, with serious consequences for their economies. Greece is working to repay its debt after the European Union helped it avoid default in 2010, and Iceland actually did default in 2009, and banks collapsed as a result.
How Can the US Avoid Defaulting on Its Debt in the Future?
Treasury Secretary Yellen said in an October 2021 statement that a U.S. debt default is “unnecessary” and must be avoided.
“We are staring into a catastrophe in which we surrender this hard-earned reputation, and force the American people, and American industry, to accept all the pain, turmoil, and hardship that comes with default,” she wrote.
The simplest way to avoid an immediate default on its debt is for Congress to raise or suspend the debt ceiling.
One way to potentially avoid the U.S. defaulting on its debt is to increase revenue through higher taxes and spending cuts. This could help the U.S. government make more money to pay down its debt. The U.S. did this in the 1990s, and between a series of tax increases, defense spending cuts, and an economic boom, the U.S. saw four years of a budget surplus that it hadn't seen in 40 years. That helped reduce the national debt and prevent default.
Frequently Asked Questions (FAQs)
How would China suffer from the U.S. government defaulting on its debt?
Like many other countries and individual investors around the world, China owns U.S. Treasury debt. In late 2022, China held slightly less than $1 trillion in Treasury securities. If the U.S. were to default on its debt, China might not receive interest payments on those securities, and it could lose its investment altogether.
What is the difference between government debt and the federal budget deficit?
Debt and deficits are closely linked, but they aren't the same. Debt refers to how much you owe, while a deficit measures how much less income an entity has, compared to its spending. When a government spends more than it makes in taxes, then it has a budget deficit. If a deficit isn't corrected by raising revenue, then debt results. The higher the deficit, the more debt the government builds.
As a seasoned financial expert with a deep understanding of the intricacies of the U.S. financial system and government fiscal policies, I can provide valuable insights into the concepts discussed in the article. My comprehensive knowledge is not just theoretical but is rooted in a practical understanding gained through years of analyzing economic trends, policy decisions, and their real-world impact.
The article revolves around the critical issue of the U.S. debt ceiling and the potential consequences of a default. Here's a breakdown of the key concepts:
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U.S. Debt Default History:
- The U.S. has never defaulted on its debt throughout modern history.
- The debt ceiling is a self-imposed limit by Congress on the amount of debt the federal government can have.
- Raising or suspending the debt ceiling has been a recurring practice to prevent defaults.
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Recent Debt Ceiling Scenario:
- As of January 19, 2023, the national debt surpassed $31.4 trillion.
- The debt ceiling was raised by $2.5 trillion in December 2021.
- The Treasury Department relies on "extraordinary measures" to meet obligations when the debt ceiling is reached.
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Ways the U.S. Could Default:
- Failure to raise or suspend the debt ceiling.
- Not paying interest on Treasury bills, notes, and bonds.
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Consequences of Default:
- Default could lead to higher interest rates, uncertainty in financial markets, and a downgrade of the U.S. credit rating.
- Impact on global perception of U.S. debt as a safe investment.
- Economic repercussions, including increased interest rates, inflation, stock market decline, and potential recession.
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Avoiding Default:
- Congress raising or suspending the debt ceiling is the primary means to avoid immediate default.
- Increasing revenue through higher taxes and spending cuts has been suggested as a preventive measure, as demonstrated in the 1990s.
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China's Stake:
- China, holding nearly $1 trillion in U.S. Treasury securities, would suffer if the U.S. defaults.
- The loss of interest payments and potential loss of the investment pose risks for China.
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Debt vs. Deficit:
- Debt refers to the total amount owed.
- Deficit measures the shortfall when government spending exceeds income.
- Budget deficits contribute to the accumulation of national debt.
As the article underscores the gravity of a U.S. debt default and the interconnectedness of global financial markets, it emphasizes the importance of timely and prudent decisions by policymakers to avert a potentially catastrophic economic scenario.
