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Permanently Suspend the Debt Limit

Christopher M. Russo
The Hill
Published May 17, 2021 (800 words)

Our nation risks another self-inflicted wound when the debt limit suspension expires on July 31. Allowing expiration exposes the nation to emergencies, harms our public credit and financial stability, and does not solve the federal government’s long-term budget problems. Congress and the president should marry a permanent suspension of the debt limit with real economic reforms. Time is running out.

When the debt limit suspension expires, the debt limit is automatically raised to accommodate all Treasury obligations issued during the suspension period. The Treasury will then be exactly at the debt limit, and can continue to finance the government for a limited time using “extraordinary measures.” These intentional legal loopholes allow officials to continue to issue public debt by shifting around intragovernmental IOUs. For example, it can “underinvest” in the retirement benefits of federal employees.

Keep in mind, extraordinary measures aren’t a government shutdown or a spending cap. While the Treasury can temporarily slash debt issuance to stay under the limit, it will still be required to meet all existing obligations using its limited cash.

During this time, the Treasury’s cash on hand will be dangerously low, risking default on those obligations. In an emergency, it might run out of cash sooner than expected. If the emergency was disruptive enough to cause a loss of market access, it would be too late to raise more funds. These are not fanciful anxieties. Remember the Sept. 11 terror attacks or Hurricane Sandy’s effect on New York City?

While at the New York Fed, I forecasted Treasury’s finances and advised officials on the debt limit. I know that Treasury and Fed officials have taken steps to prepare for terrorism, disasters, and more. But contingency planning is never foolproof. Could the New York Fed conduct Treasury auctions? Could market participants bid? Could their payments settle? It’s impossible to be certain and should not be risked.

Even if the debt limit is eventually re-suspended without alarm, the risk of default still harms our public credit. The nation can borrow so much, at such low rates, only because the world perceives that Treasury debt is risk free. Lenders believe the government will make timely principal and interest payments, and also that it will not print money and inflate away the real value of the debt. These perceptions have been set by two centuries of institutional credibility, but perceptions are fragile. Talk of a mere “technical default,” in which the Treasury misses a debt payment because of the debt limit, is just political euphemism.

Once the debt limit is re-suspended after an expiration, Treasury would ramp up debt issuance to rebuild its cash balances. In doing so, we would risk financial market dysfunction. In the aftermath of the last debt limit episode, Treasury markets froze and short-term yields spiked, which lowered the value of bank capital and derivatives collateral. This dysfunction caused the Fed to restart asset purchase and repurchase programs, ending the short-lived attempt at balance sheet normalization. As a former Federal Reserve Chair, Treasury Secretary Yellen is aware of these facts.

In the past decade, elected officials have used the debt limit as a negotiating chit for budget concessions. Officials may wait to debate until after the suspension expires and re-suspend only once we are close to default.

I say to those officials: In Washington, politics is fair play, but look at the result. Public debt was 100 percent of GDP at the end of the last fiscal year, rising by 65 percentage points since the start of the Great Recession. The Congressional Budget Office projects that this ratio will grow to all-time highs by 2031. Worse, these figures ignore Treasury’s many off-balance-sheet liabilities, including the looming insolvency of the Highway Trust Fund (FY 2022), Medicare Part A (FY 2026), and Social Security (early 2030s). The debt limit has not been an effective tool for solving the federal government’s long-term budget problems. Considering its harms, you should permanently suspend it.

Seeing that interest rates and inflation have stayed low so far, other elected officials have become too sanguine about debt. In the words of Carmen Reinhart and Kenneth Rogoff, lawmakers have come to believe that “this time is different.” It is not. The real value of U.S. debt — including the public’s dollars — depends on the government backing it with sufficient tax revenue. As a result, debt limit reform is only meaningful if married to economic reforms.

Lawmakers must put the nation’s budget on a sustainable path. Doing so will require both budgetary reforms to control the deficit and structural reforms to grow the economy. My Mercatus Center colleagues have developed evidence-based proposals up to the task. Here are a few.

The debt limit is our dangling sword of Damocles. It will fall down on our head without warning. A permanent suspension would permanently sheath it.