Something Extraordinary in the Air

I’m sure you noticed it — that subtle hint of something different and unusual, even extraordinary, in the air. No, the Fed has not returned to zero rates, quantitative easing, and other “extraordinary” monetary policies. Instead, on March 2 the federal debt limit snapped back into place and the U.S. Treasury immediately began using its “extraordinary measures” to keep the debt under the limit.

Ok, you didn’t notice. That’s good because it means no disruption has occurred. Here is what is going on.

By law there is a limit on federal debt (where federal debt, roughly speaking, is the total of debt issued to the public and federal agencies). Under the Bipartisan Budget Act of 2018, the debt limit was suspended through March 1, 2019, at which time the new limit automatically became the amount of debt outstanding. Now the Treasury has to live with the new cap (which is a bit north of $22 trillion). In broad terms, the way it does this is to stop issuing Treasuries to federal agencies, which allows it to issue more to borrow from the public. In particular, the Treasury can stop issuing Treasuries to the Thrift Savings Plan’s “G Fund,” which is a retirement program for federal workers; suspend funding the exchange Stabilization Fund, a pool of funds in Treasury that is a legacy of the fixed exchange rate era; and stop giving securities to the Civil Service Retirement and Disability Fund and the Postal Service Retiree Health Benefits Fund. These so-called extraordinary measures can keep the debt under the limit to the August-September time period.

But the extraordinary measures eventually run out, and the debt limit must ultimately be raised (or suspended). Failure to do so would mean that the Treasury could not borrow to make good on the interest and principal on previous borrowing — a default. Default on Treasuries would undermine the safe investment that is the foundation of liquidity in the global financial system and have profound negative impacts on the global economy. It is unthinkable.

How will the debt limit get raised? There are two, related aspects to this question. The first is the process for raising the debt limit. Usually, it would require passing legislation in the regular fashion through the House and Senate. But upon taking control of the House, the Democrats instituted a new rule with the following feature: If the House passes a budget resolution, then passage automatically triggers sending a House-passed debt limit suspension bill to the Senate. In that circumstance, the Senate could take up the bill, pass it, and send it to the president for signature. Voila! Problem solved.

Not so fast. The second aspect is what policy content will be required to raise or suspend the limit. The scenario outlined above is a “clean” suspension, but such clean increases or suspensions are historically the exception and not the rule. Instead, part of the price of raising the debt limit is usually provisions designed to force Congress to be more fiscally prudent in the future. If enough members of the House or Senate require this, then passage requires regular order and not the expedited procedure under House rules.

The debt limit will soon fade from the national consciousness, and the extraordinary sense in the air will return to the mundane. But in a matter of months, the debt limit will be front and center.