May 9, 2023

This post summarizes a Twitter thread I posted on May 7, 2023.

1. A short Q&A about the debt limit. First of all, where did it come from?

2. Article I, Section 8 of the Constitution assigns Congress the power to incur debt. Prior to World War I, it directly authorized each issuance of government bonds on a case by case basis.

3. During World War I, this became unworkable and it decided to instead authorize an overall limit or “ceiling” on the amount of war bonds that could be sold, up to a certain amount.

4. In 1939 and 1941, gearing up for another war, this evolved into an authorized ceiling on the total national debt, essentially delegating the sale of securities to the Treasury up to a certain amount.

5. Ironically, then, the debt ceiling, as we know it today, was originally intended to LOOSEN constraints on the Treasury managing the national debt, not impose them.

6. Up until 2011, the debt ceiling was regularly raised as a pro forma step, simply giving Treasury the authority to facilitate the taxing and spending decisions already made by Congress.

7. Next question: when the country near the debt ceiling, there’s always talk about the Treasury taking “extraordinary measures” to push back a default. What exactly are these measures?

8. Long story short, as I understand it, it temporary underfunds or raids federal pension funds, as well as the special fund it uses to stabilize the dollar exchange rate.

9. By withholding scheduled payments into these funds, or redeeming investments early, it generates the cash flow needed to meet other obligations. When the debt ceiling gets raised, it pays back into them, and hopefully no one is any the wiser.

10. But these measures aren’t sufficient over the long run, so it can only play this game for a few months (exactly how long depends on a lot of factors, which is why we’re never entirely sure when a default might come if the ceiling isn’t raised).

11. If the debt ceiling isn’t raised, and extraordinary measures aren’t sufficient, what happens? Will the federal government start defaulting on its debt? What else could the President do to prevent that?

12. Some argue that Treasury could prioritize certain payments over others, avoiding a default on the most visible and market-sensitive instruments like publicly-traded bonds.

13. There are two problems with this. First, it’s not clear that Treasury has the legal authority to prioritize some creditors over others.

14. Second, this comes awfully close to Congress tacitly granting the President the power to pick and choose what to spend congressionally appropriated money on, or not, as he sees fit (a power called impoundment).

15. Back in the 1970s, Congress fought tooth and nail to DENY this power to President Nixon, ultimately passing law in 1974 making it illegal. This would be a huge grant of power back to the presidency.

16. So prioritizing payments is at least problematic, from a constitutional point of view, and probably not the outcome Congress would really like, if it sits down and thinks about it hard.

17. Another potential way to avoid default would be for the President to invoke the 14th Amendment, which states that “the validity of the public debt of the United States … shall not be questioned.”

18. This Amendment was meant prevent a future Congress, perhaps dominated by Democrats from the old Confederacy, from cancelling the war debt incurred to fight the Civil War.

19. It is far from clear, however, that this amendment negates Article I, Section 8 which assigns Congress the power to authorize all new debt issuance.

20. Alternatively, some have proposed “minting the coin”. This involves a somewhat oddball scheme to use a legal loophole to create more money for Treasury to spend.

21. In 1996, Congress passed a law aimed at coin collectors, which gave Treasury the authority to mint coins of any denomination in platinum. Nobody gave any thought to any broader implications.

22. During the 2011 debt ceiling stand-off, some commentators proposed using this loophole to mint a coin, assign it a legal value of $1 trillion, and sell it to the Federal Reserve for the funds needed to keep meeting its obligations.

23. The guy who originally came up with this idea actually follows me here on Twitter, @mucha_carlos.

24. On the positive side, one could argue that this way of creating money is really no more artificial than money-printing or other ways the government already creates fiat currency.

25. It would not, as some critics contend, directly unleash hyperinflation by injecting $1 trillion in the economy, because the only money that would actually enter the economy would be the continued government spending at existing levels.

26. However, the very novelty and transparency of the move could raise a host of uncertainties that could potentially unsettle market confidence in the value of the dollar and US debt.

27. Not least of which is, if Treasury can just mint a coin and call it $1 trillion, it raises all kinds of questions how that power might be abused in the future.

28. It’s also a loophole that Congress (unintentionally) created, and could therefore shut down. Though I presume the President would try to veto any such change, in the midst of a debt ceiling standoff.

29. It’s also a strategy that the Fed would have to play along with, by buying the coin for $1 trillion. It’s not clear that it would be willing to do so, or even legally could.

30. So if extraordinary measures run out, there are a number of options the President could exercise to prevent a default, though each of them is problematic in its own way.

31. That said, if you’re the President and your advisors tell you that the US will default on its debt and markets will melt down tomorrow unless you do one of these things, are you really going to NOT do something?

32. And if you’re the Fed, and you’re told that the US will default and markets will melt down tomorrow unless you accept the coin, are you really going to refuse?

33. What would be the implications of a default, if it couldn’t be avoided? Honestly no one knows.

34. There was an unintentionally default on Treasury bonds in 1979, due to a check-processing glitch, and markets brushed it off as an aberration.

35. When the credit rating of US debt was downgraded after the 2011 standoff, even though there was no default, it did raise the cost of default insurance on US debt somewhat.

36. Analysts have calculated that the downgrade in US credit rating added a few billion dollars to what interests payments otherwise would have been, over the following years.

37. But these additional interest payments paled in comparison to the impact of interest rate fluctuations, positive and negative, due to other economic conditions.

38. So if the US defaulted due to the debt ceiling, markets might brush it off, or it might be the end of the dollar and Western civilization. At this point, we leave the realm of measurable finance and economics and enter the trickier domain of human psychology.

39. But I think it’s dangerous to assume markets won’t see it as a serious development that erodes US credibility. At the very least, it’s a game of Russian roulette that no sane person should want to play.

40. In any case, you can’t really just “get rid of” the debt ceiling, as some have advocated. Eliminating it would actually be more restrictive: Congress would have to authorize each new issuance of bonds, as it did before World War I. Which would be unmanageable.