Washington Update

A Closer Look at the Federal Debt Limit

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According to a Congressional Research Service (CRS) report, Congress has always restricted federal debt. A 1917 law included an aggregate limit on federal debt, as well as limits on specific debt issues. During the Depression era, Congress altered the form of those restrictions to give the U.S. Treasury more flexibility in debt management and to allow for the modernization of federal financing. A general limit was placed on federal debt in 1939.

The statutory debt limit applies to almost all federal debt. The limit applies to federal debt held by the public, as well as to federal debt held by the government’s own accounts. Federal trust funds, such as Social Security, Medicare and Civil Service Retirement accounts, make up most of that internally held debt.

Increases or decreases in debt held by government accounts result from net financial flows into accounts holding the debt, according to CRS. Legal requirements and government accounting practices also affect the levels of debt in government accounts.

The Treasury Department usually has to cover the gap between income and expenditures by borrowing on international money markets. The United States has been able to borrow at low interest rates on those markets, which has helped keep interest rates low for consumers. A future default, as President Obama frequently warned, could cripple confidence and cause the cost of borrowing to soar.

Because U.S. Treasury bonds have always been regarded as a safe investment, a U.S. default would greatly alarm financial markets. The BBC reported that while investors could be prepared to wait out a short disruption, a lengthier default might lead to money being switched into other potential safe havens, such as debt from Switzerland or Germany. Another possible effect, the BBC said, could be a rush to buy gold, which traditionally has been seen as a safe investment.
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