A brief guide to the US debt ceiling

US debt officially broke $20 trillion mark

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As a trader, one might have heard about the term “US debt ceiling.” Once a year, this topic dominates the news wires. The US debt ceiling took even more importance when in 2013 the United States federal government was shut down for 16 days in October.

The shutdown which occurred due to the debt ceiling not being raised prevented most of the routine operations which led to nearly 800,000 federal employees being furloughed or a temporary leave. At the same time, nearly 1.3 million federal employees were asked to work without knowing whether they would be paid or not.

The US Congress enacted the debt ceiling act in 1917 in an effort to assist the US Treasury department to borrow without approval as long as the limit wasn’t reached.

So what is the debt limit or the debt ceiling?

The debt ceiling is a legal limit put in place the US Congress. It puts a cap on how much debt the federal government can have at a given time. When the debt ceiling or the limit is reached, the United States Treasury cannot issue more debt (bills, notes, bonds). The US Congress interestingly is also responsible for spending as well.

When the debt ceiling is reached, the United States Treasury can only carry out its operations from the tax revenues. Due to the inadequacy of funds, the Treasury department prioritizes payments and has to choose between either paying the federal employees or pay social security benefits and interest on the national debt.

The United States debt ceiling can be compared to the spending limits imposed on a regular credit card. However, as a credit card holder you only know how much you will spend, while the credit card issuer tells you how much can spend, which is the credit card limit.

The United States debt is broadly broken down into two main categories. Part of the debt is what the government owes itself such as the Social Security Trust Fund. The second part of the debt is public debt, which is the debt owed to the public. Most of the debt in the debt ceiling falls into this second category.

The current US debt ceiling is set at $19.8 trillion on the US Treasury borrowing.

Why is there a debt limit?

One might have heard the term of living within one’s means. While this might be true for most individuals, governments can only work on a deficit. This means that governments tend to spend more than what it can collect. This is also known as a deficit.

In order to make up for this deficit, governments borrow money by issuing debt in the forms of bonds with different tenors. The debt limit legally imposes a restriction on how much money can be borrowed.

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Despite the term “limit” the US Congress has steadily increased the debt ceiling over the years. It is also important to understand that raising the debt ceiling does not mean borrowing more to spend. On the contrary, the debt ceiling is raised in order for the United States Government to meet its existing debt obligations. Examples of these include paying bond holders the interest and paying the citizens by means of social security spending.

What happens when the debt ceiling is reached?

Reaching the debt limit is something that happens all the time. However, this is triggered by the US Treasury secretary sending a debt limit letter to the congress informing them that the Treasury will not be able to meet its obligations. Once the formal letter is sent, the discussion on raising the debt limit is started.

The Treasury department also enacts “extraordinary measures” in order to temporarily finance the government’s expenditures and obligations. This occurs even before the debt limit is enacted and allows law makers time to debate on it.

Impact of the debt ceiling in the forex markets

Debt is one of the key things that influence the exchange rate. If a sovereign nation is perceived to have high national debt and it is unable to manage its debt, it can have unintended consequences on the nation’s currency.

It is important to note that while debt in some countries continues to increase, it is the plan to deal with the debt that matters. Therefore, despite the US government shutdown in 2013 October, the markets remained relatively calm. Another factor that pays a role is the economic growth of the nation as well.

Although one might think that only poor countries have high levels of debt, it is in fact the opposite. Some of the nations with highest debt levels are the most advanced economies. The United States leads with the highest external debt. However, when compared to GDP, it is only 97%.

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