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Lesson #30 : THE DEBT CEILING IN THE UNITED STATES

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Due to the lack of response to Friday’s JuicyLesson on the ideological continuum as well as the fact that I covered more than expected on the subject of the continuum, I have decided to turn the page on this philosophical discussion and move on with a new topic rather than continuing to discuss the ideological continuum today as I originally intended to do.

THE DEBT CEILING IN THE UNITED STATES

A certain problem which may or may not occur as a consequence of the government shutdown in the United States is a possible default by the American government resulting in that administration not being able to pay it’s bills.

The government is an economic agent like a consumer and like a consumer has bills which must be paid when they become due. Consumers have mortgage payments to make as well as electricity, phone, credit card, car and other charges they must deal with monthly. The U.S. government has interest payments to make on bonds, T-bills and other securities it has sold to its own citizens as well as to foreign governments and nationals. The government sells me a $20,000 bond with a 2,5% interest rate attached to it. (Government bonds are sold to people as a means of borrowing money. In return for this loan, the government agrees to pay a certain rate of interest for the life of the bond, same principle as bank interest paid on registered savings plans and investment certificates, for instance, and similar to interest paid on corporate bonds and mutual funds purchased by investors on the stock market.)

Back to the $20,000 bond I purchased from the government on which said government agreed to pay an interest rate of 2,5%, or a total of $500 a year. Multiply that by the billions of dollars in bonds that the American government owes interest on and we have one bill which the state must pay.

Unless the American Congress can come to some agreement to raise their debt ceiling by October 17th, this coming Thursday, the U.S.will supposedly default on the payment of its bills, among them the billions of dollars of bond interest it owes to American bond-holders as well as to individuals, corporations and governments in other countries, Canada included.

If the U.S. government does end up defaulting then there are a couple of serious consequences which could ensue as a result. Firstly people holding bonds at the moment may decide that they no longer trust the U.S. government to pay them back and may, as a result, refuse to purchase American paper (bonds, for example) in future thus making it more difficult and, by extension, more expensive for the American federal government to borrow money.

This is the same thing that would happen to me, as a consumer, if I failed to pay my personal bills or paid them after the due date had already passed. It would become increasingly difficult for me to obtain credit and if I did manage to secure a loan or two, these would be extended to me at a high interest rate, increasing my borrowing costs.

The United States government has a national debt of almost seventeen trillion dollars. The Debt Ceiling or debt limit is actually a legislative mechanism to limit the amount of money theTreasury Department has at its disposal to make payments due on the national debt, including the interest payments on the $20k bond discussed above. The debt ceiling will be reached on October 17th unless the Congress can somehow get it together to raise the ceiling or limit. (Wikipedia). If that doesn’t happen, it is possible that unless the Congress takes what Wikipedia calls “extraordinary measures”, the results could be disastrous for the American economy including a decline in production, a recession, as well as a downgrade in the American credit rating (as happened for the first time in U.S. history in 2011 when they came really close to not raising the debt ceiling on time) and an overall increase in borrowing costs.

There is of course a chance that when we reach October 17th in the absence of the passage of a new debt ceiling, nothing will happen and life will continue as normal but there is the possibility that as long as the American government shutdown continues, there is a definite chance that the debt limit will not be raised on time and that serious economic consequences will accrue. Why take that chance?

Peace.

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