The Conversation

By Luke Freedman

The last-minute fiscal cliff deal was narrow in scope; President Barack Obama and the Democrats got less tax revenue and far less stimulus spending than they were hoping for, but there weren’t any cuts to entitlement programs either. One can debate whether this bare bones compromise was preferable to a broader grand bargain on debt reduction, but it certainly refocuses attention on the February vote to raise the debt ceiling. Congressional Republicans who were unhappy with the lack of spending cuts in the fiscal cliff deal may decide to play hardball in this next dispute.

Here’s how the debt ceiling works. All federal spending must be authorised by Congress. If the government doesn’t have enough revenue to pay for approved expenditures than the Department of Treasury issues debt to make up the difference by selling government bonds or notes.

The debt ceiling limits the amount the Treasury can borrow. When more funds are needed to cover costs Congress has to vote to raise the debt ceiling.

Congress isn’t making any novel decisions on fiscal policy by raising the debt ceiling; they’re simply affirming that the government should pay for the budgets that the House and Senate have previously approved. As Atlantic Correspondent James Fallows notes, the debt ceiling “makes exactly as much sense as it would for a family to decide whether to pay a credit-card bill for goods it has already bought.”

Luckily, votes to raise the debt ceiling have historically been uncontroversial. Some members of Congress use the occasion to rail against perceived fiscal irresponsibility, but the thought of allowing the US to default on its debt was considered beyond the pale.

This all changed after the Republicans' sweeping victory in the 2010 midterms. The new crop of Tea Party congressmen were determined to crack down on what they saw as out of control government spending, and they were willing to use any means necessary to do so.

Consequently, the 2011 debt ceiling voted ended up being anything but routine. Republicans threatened to block any increase on the debt limit unless Democrats agreed to dramatic and instantaneous spending cuts.

President Obama and Speaker of the House John Boehner eventually reached an 11th hour agreement before the borrowing limit was reached, but the damage was already severe.

The prospect of the world’s largest economy failing to pay its debt sent global markets into a panic and left lingering questions about the US government’s reliability. In early August, the financial services company Standard & Poor’s downgraded America’s credit rating from AAA to AA+. And the Bipartisan Policy Center estimates that increased borrowing costs as a result of the standoff will cost the US $18.9 billion over the next ten years.

Consequently, there’s a lot at stake in the upcoming debt ceiling vote. The possibility of not reaching an agreement had significant consequences in 2011, but an actual failure to raise the debt ceiling would be far worse.

In spite of the previous turmoil US Treasury bonds are still considered incredibly safe assets. This faith in American credit has led US interest rates to be used as a “benchmark for all other sorts of debt" according to Ezra Klein of the Washington Post. An extended debt crisis in which interest rates rose sharply would destabilise a central pillar of the American and world economy.

The government would have cash on hand to continue paying interest on the debt for the immediate future, but doing so would mean defunding nearly all other programs. Government employees would be out of work, most government operations would cease to function, and an enormous amount of money would be sucked out of the economy at a time when the recovery is still fragile.

I remain fairly optimistic that it won’t come to this. The Tea Party’s influence isn’t quite as strong as it was during the last confrontation, and Republican leadership has to realise how disastrous it would be for the government to default on its obligations. Further, the public and business community are not going to look favourably upon politicians who engage in brinkmanship over such a crucial issue.

But, given the dysfunctionality of the US Congress in recent years, you can never be certain of a sane outcome.

This article was originally published by The Conversation