What’s a debt ceiling, anyway... and why does the US have one?

In 1917, a country that had mostly avoided entanglements with the outside world for the first 140 years of its existence jumped into a world war.

People in the US worried about its loss of neutrality when their government joined in the hostilities in Europe – and about the fact that this kind of geopolitical policy change was going to be expensive. So a few months later, lawmakers established the country’s first debt ceiling. Raising it to borrow more money would mean having to go through them first, theoretically discouraging profligate spending.

Fast forward a bit more than a century. The US now keeps hundreds of thousands of military personnel stationed overseas, and it’s locked into a dispute over recalibrating its debt ceiling for the 79th time since 1960. Failing to do so could trigger calamity.

The dustup shines a light on the fact that there are different ways countries choose to balance their books, often without such built-in drama. It also points to possible direct consequences for relatively vulnerable developing economies, at a particularly bad time.

US national debt has been steadily ticking towards $31.5 trillion. Officially, the government hit its debt ceiling in January (which is still $31.381 trillion, for those keeping score). Since then, extraordinary measures have been used to buy time, amid warnings that the government won’t be able to fund its operations much longer. The possible impacts of what would be the country's first-ever default are being scrutinized.

Denmark is the only other advanced economy that uses a debt ceiling. But it’s generally set so high that it ends up being no more than a formality.

Other countries tend to focus on debt as a portion of their economic output, rather than setting a hard limit. In the EU, the government debt-to-GDP ratio for member states as of the end of last year ranged from 18.4% in Estonia to 171.3% in Greece.

The equivalent figure for the US at that point was 120%.

While it's true that the US has never defaulted by failing to make payments on what it borrows to fund everything from military salaries to health insurance for the elderly, plenty of other countries have.

According to one running tally, the collective amount of sovereign debt in default as of 2021 was $375 billion.

Traditionally, cash-strapped countries in distress would have their payments rescheduled by the Paris Club, a “non-institution” made up of representatives from wealthy, mostly Western nations – in tandem with actual international financial institutions like the IMF.

Lately, the process has become more complicated. That’s because the number of big lenders in the world has expanded, and they don’t necessarily coordinate very well.

Experts say this has resulted in more protracted and painful resolutions – and at a time when many developing countries are struggling under the weight of debt piled up during the pandemic.

Between 2021 and 2022, the world’s poorest countries were expected to see their external debt service payments increase by more than a third.

And a recently-published IMF list of countries either at high risk of slipping into debt distress, or already there, is long.

Ghana provided one positive recent storyline, when its creditors managed to come together to formulate a debt restructuring deal for the country as it faces a severe economic crisis. That was hailed as proof that progress is possible.

Now, though, it’s unclear what impact the debt ceiling impasse in the US might have on the global situation. Negotiators have a bit more than a week to get a deal passed, before the US government will be unable to pay its bills.

Some suggest a weakened dollar resulting from the imbroglio would make debt denominated in other currencies more expensive, maybe even tipping some emerging economies (not already there) into debt crises as a result.

Others note that the pain of a US default would be felt in just about every type of country. “No corner of the global economy will be spared,” one economist said.

The last time political parties the US seriously struggled to agree on raising the debt ceiling, in 2011, the country’s credit rating was downgraded and financial markets tanked. Once again, an elusive congressional vote in favour of a ceiling bump will be needed to prevent financial pandemonium.

A recent poll found that a third of American respondents were “extremely” concerned about the impact the debt ceiling might have; significantly more said they didn’t really understand the debate over raising it.

Some suggested ways around the standoff have included simply minting a $1 trillion platinum coin and depositing it with the central bank, or issuing unorthodox “premium bonds.”

The haggling is a longstanding tradition.

In May 1944, just a month before US troops would be deposited on beaches in France on D-Day to help bring another world war to a close, members of the US Congress were fighting their own battle over – what else – the debt ceiling.

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