What is the debt ceiling?

Its a numeric limit on the total debt that the US Treasury is allowed to issue. Theres no debt ceiling in the US Constitution. Instead, its imposed by statute.

Theres no legal requirement for that statute. The debt ceiling could be repealed by Congress, at which point there would be no limit on the size of the national debt.

Still, Congress likes the idea of a debt ceiling. It forces the White House and Treasury to come back to Congress from time to time to request increases as needed. This gives Congress some leverage to ask for political concessions in return for raising the debt ceiling.

So, the debt ceiling is really a political football rather than a serious macroeconomic policy tool. In the end, Congress always approves the ceiling increases. In a way, the debt ceiling debate is all for show.

To be clear, the debt ceiling does not mean the Treasury cannot issue any new debt. It means that Treasury cannot issue debt that increases the total outstanding above the ceiling.

Getting around the debt ceiling a shell game of dodgy options

Treasury is at the ceiling now.

The US is still running deficits. How are the new deficits being financed? The Treasury has to resort to extraordinary measures to keep paying the bills. Lets look at some of their options.

The Treasury has several slush funds, such as the Exchange Stabilisation Fund, that it can tap into to pay bills without Congressional approval. Believe it or not, the Treasury sometimes has positive cash flow even though the deficit is increasing. This happens around this time of year when more Americans are paying their taxes than are claiming refunds.

This positive cash flow can help the Treasury pay bills temporarily, even if a dry spell emerges late in the year. (This typically happens in the summer when tax payments slow down and use it or lose it spending increases.) Finally, the Treasury can sell assets (Grand Canyon, anyone?) to put some cash in the till.

A trillion-dollar coin?

You may have heard of the trillion-dollar coin idea. It wont happen, but heres how it works.

The Treasury would ask the US mint to produce a solid platinum coin. The Treasury would give the coin to the Federal Reserve and simply declare that the coin was worth US$1 trillion. (Assuming it to be a one-ounce coin, the actual market price is about US$1,000.)

The Fed would put the coin in a vault and credit the US Treasury general account US$1 trillion. The Treasury could spend that newly printed money as it wished. The Treasury would not violate the debt ceiling because no new debt would be issued; the Fed would just create the dollars out of thin air. Easy breezy.

I spent most of 2022 asking anyone who would listen a simple question: Why has nobody blown up yet? Why hasnt there been a bank crisis? Why has no pension fund imploded? Why havent insurance companies gone haywire?

You see, we had one of the worst years ever for financial markets, in the US in particular. That was especially true because bonds and stocks had fallen together during a period of inflation.

A balanced portfolio of US stocks and bonds wouldve delivered the worst return since before the Great Depression, according to my calculations.

The result was unusually bad because stocks and bonds are supposed to offset each other. A bad year in stocks is supposed to be offset by a good year in bonds. Thats the whole point of owning such a diversified portfolio. But the theory failed in 2022. Both plunged, with inflation adding insult to injury.

And yet, no financial institution had blown up in spectacular fashion. There was no Lehman Brothers moment. No sovereign default or currency peg breaking. We couldnt even come up with a proper name for the 2022 crash because there was no single particularly noticeable event to name it after.

This completely mystified me at the time. How could risk free, 30-year UK Government bonds crash 60% without sending UK financial institutions into meltdown, for example?

I asked a series of famous thinkers this question over and over again, usually in the moments after recording an interview with them on some other topic. They all told me a variety of reasons that werent very convincing.

Some said that banks had hedged their exposures and risks to the crashes in derivatives markets.

Others said that financial institutions didnt hold the long-term bonds that had fallen especially badly.

Others said that the revenue benefits of higher interest rates outweighed the capital losses for financial institutions. (Higher interest rates mean more profits for banks and insurance companies.)

This all seemed fair enough. Even if I didnt see how it could quite offset the vast losses that financial institutions must have suffered on the value of their assets.

For example, if you use derivatives to evade losses on bond prices falling, that merely transfers the loss to someone else. Its still being suffered by someone.

Another reason experts frequently gave me to explain the financial systems stability in the face of such losses particularly annoyed me. In fact, I remember losing my temper and interrupting one patient colleague about it in a rather rude way.

The former banker, who had quit his job in anticipation of the 2008 financial crisis, claimed the post-financial crisis reforms had made banks and other financial institutions less risky. They held more capital in reserves.

This seriously annoyed me because it was like claiming that banks were safe in 2006 because of securitisation. A claim that many peopl...