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What Is The Debt Ceiling?

in Debt 101

Lately there has been an awful lot of talk about the federal budget and the debt ceiling. The debt ceiling is the maximum amount of money the Treasury is allowed to borrow to pay the obligations of the Federal Government. Congress sets the number and has the power to change it if they feel it is in the best interest of the country.

The origin of the debt ceiling dates back to 1917 when the United States entered World War I. In order to finance the war, Congress authorized the Treasury Department to issue long-term bonds that would raise the money needed to fight and win the war. At the same time they allowed bonds to be issued, they also placed a limit on the amount of money that could be borrowed.

Over the years, the ceiling has been raised and also lowered on several occasions. The maximum allowable amount that can be borrowed is often reflected as a percentage of the nation’s Gross Domestic Product (GDP). At its highest point, shortly after WWII, the amount we owed was 120% of GDP. More recently, it was at a low of about 35% of GDP under President Carter and then rose quickly to more than 60% under the Reagan and first Bush administrations. Bill Clinton’s presidency reversed the trend and then it went right up again under George W. Bush. Today, under Obama we are right at 100% of GDP.

All of the uproar and the commotion between Congress and the President concerning the debt ceiling begs the question as to why the debt ceiling is so important. In the simplest of terms, the US Government is taking in less revenue than it is obligated to pay out. Unless they can borrow more money, they will not be able to pay all their bills as they come due.

The implications of the United States not being able to pay their creditors as scheduled can cause the cost of borrowing money in the future to rise. As with anyone that borrows money, if you are late on your payments, your credit worthiness will suffer and it will be harder for you to borrow money in the future. The massive federal debt will cost more to service, as the Federal Government will be forced to offer a higher interest rate to attract buyers of their bonds and other fund-raising financial instruments. Those higher costs will be passed on throughout the economy and everything from mortgages, car loans and credit cards will cost the general public more.

Not only would a serious crisis develop very quickly, but, such a scenario could plunge us back into a deep recession that might take years from which to recover.

The easiest solution would be to raise the debt ceiling so the government can issue more debt to finance its current obligations. While this does not solve the long term problem of ever-increasing debt, it does delay the inevitable crisis.

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Unfortunately, there is no good or easy permanent solution to this growing crisis. While the Democrats and Republicans cannot seem to agree on a solution to the problem, there is one thing that they can agree on. It is going to take a great deal of sacrifice and plenty of suffering by the American people to get our debt under control. Maybe taxes will have to be raised and maybe spending on social programs will have to be cut back. America needs to be prepared to accept less government services and pay more of their income in taxes. It is not a pretty picture, but it is reality.

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