Will Debt Ceiling Brinksmanship Affect US Securities?

by Aman Verjee

The US and Denmark are the only two countries in the world that have a “debt ceiling,” which is a legislatively imposed limit on the aggregate amount of debt that the government can incur. In other nations, the legislature and / or executive branches run a budget process that includes an automatic approval of any borrowing required to fund any deficit that the budget incurs, but in the US and Denmark, the legislature has to separately approve an authorization to borrow — kind of like your bank increasing a spending limit on a credit card.

Some economists and pundits, like Alan Blinder here and Matt Levine here, and also Matt Yglesias here, seem to think it’s a bad idea to put these spending limits on the federal government, though literally every American family, corporation and institution (including the fifty states) all have limits on borrowing and have to live within its means and in these contexts a debt limit is not really a weird idea.

Anyway, I have no idea how this happened in Denmark.

In the US, the debt limit came about during World War I as a largely procedural measure to manage spending. Every year from 1917 to 1994, Congress raised the debt limit without much of a fuss, but in 1995 (and then again in 2011 and in 2013) Republicans in Congress refused to raise the debt limit as a way to force a Democratic president to reduce spending.

This year, Republicans in Congress are threatening not to raise the debt ceiling again, until the Biden administration agrees to deep spending cuts after the last three years of record-setting deficits and federal outlays. The US technically breached its debt limit in the middle of January. For the last three months, the Treasury department has been paying its bills through what are known as “extraordinary measures” — the biggest of these is having the Treasury borrow from the retirement accounts of federal workers. (Don’t try that if you’re running a company, but turns out that the Treasury is allowed to do this.)

Should investors be worried about this? If the US comes close to a default on the debt, will interest rates rise and stocks fall?

The Experience of 1995–1996

Consider what happened the last few times that the US hit the debt ceiling, and Congress used this procedural vote as a way to bargain with a free-spending White House.