Recently (9/21/2021), the U.S. House passed a bill that would fund the government while also suspending the debt limit until December of 2022. However, this bill still has to be passed by the U.S. Senate in order to become true legislation. If the Senate does not pass the bill then the U.S. government would shutdown on October 1st. In addition, without an increase to the debt limit, the country would default on its debts. This is extremely significant because this would be the first time the U.S. has ever defaulted.
The fact that the U.S. has never defaulted on its debt has given it one of, if not, the strongest credit worthiness rating in the world. Strong credit worthiness makes the dollar stronger and also allows the country to lend and borrow more freely. However, one single default could leave a heavy mark on the United States’s credit rating. The U.S. is a large lender and borrower due to its credit rating. So if the country defaulted for the first time, it could signify instability in the U.S. government and put into question how credit worthy the U.S. truly is.
Of course, this scenario has happened multiple times before in the past, and each time the government was able to increase the debt limit to pay off its debts. Despite this, past outcomes do not always indicate future outcomes. It is still stressful to “roll the dice” each time. Especially when one bad outcome can have such a drastic impact on the country. So how exactly does the U.S. pay its debts and why does the debt ceiling need an increase?
How the U.S. Pays Its Debts
To understand how the U.S. pays its debts, it’s important to understand how the U.S. accumulates debt. The U.S. accumulates debt when it decides to spend more than it earns from taxes. Generally, this means that there is a budget deficit. In order to finance the country’s spending, the government issues bonds. This gives the government money to finance its spending and promises bondholders they will be paid back in the future.
The only issue with issuing is that there is a limit on how much debt the U.S. can issue. This is known as the “debt limit” or “debt ceiling”. If the U.S. issues its max amount of debt and still does not have enough money to pay for its spending obligations then the government will shutdown and debts may be defaulted upon. However, this changes if the debt limit is increased. Then the government can issue more debt and finance its spending, preventing any defaults or shutdowns.
Overall, this balance between budget deficit and paying debts has largely been “solved” by increasing the debt limit. The present worry is that if the U.S. fails to increase the debt limit this time, the country will embrace its first-ever default and all the consequences that come with it.
Read more on U.S. Debt: https://www.investopedia.com/updates/usa-national-debt/
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