Wednesday, January 18, 2023

Two points on the debt limit, 1 serious 1 fun

Everyone keeps repeating that hitting the debt limit would necessitate a default on principal and interest. The Treasury itself says 

Failing to increase the debt limit would have catastrophic economic consequences. It would cause the government to default on its legal obligations – an unprecedented event in American history. That would precipitate another financial crisis and threaten the jobs and savings of everyday Americans – putting the United States right back in a deep economic hole, just as the country is recovering from the recent recession.   

The first statement is correct. The second is not. The government is still hauling in tax revenues. The Treasury could easily say "given the catastrophe that a default would produce, we will always pay interest and principal on treasury debt before any other payment." Congress could pass a law stating that fact. There is no economic reason  that a debt limit should force a default. 

There is a legal argument, and a claim that the Treasury cannot prioritize debt payments over other legally mandated payments. In the research I've been able to do however, this is a very uncertain claim. And it makes no sense. The Treasury is legally obligated to make debt payments, as it is obligated to pay Social Security checks, and also legally obligated not to borrow. Law prescribes the impossible. It has to prioritize. Indeed, unpaid bills are a form of debt, so if you want  to be a stickler, the government will violate the debt limit no matter what it does. 

The second statement is false. The US has defaulted on  gold clauses in the 1930s. It has defaulted on other "legal obligations."

The third is correct, and appropriate. If we are to tussle over paying Wall Street fat cats vs. grandma's social security, keep in mind just what a catastrophe default would be. Grandma will be way worse off if that happens. Treasury debt is now the golden collateral, supporting most of the financial system. (We should have a financial system much less dependent on short term collateralized borrowing, but that's another story.) If in default it would not be. Worse, and most important here, if financial markets suspect a default will really happen, they will start refusing to accept treasury collateral in the first place. This is basically what happened in 2008 with mortgage backed securities. They didn't fall to pieces,  they just weren't acceptable as collateral any more. 

A flight from treasury collateral under a debt limit would be far worse. And the government's magic tonic, borrow a ton and bail everyone out, would be unavailable. 

Perhaps Treasury thinks that by threatening default, they can get Congress to wake up and raise the debt limit promptly. But this risks Wall Street also believing the threat and causing the panic you're trying to prevent. 

Treasury secretary Janet Yellen should say out loud, right now "we pay principal and interest on treasury debt first, before anything else." President Biden should back her up. Drastic delays in social security, medicine, government shutdown and more are plenty enough threat to get Congress to move, without risking a run. 

States with balanced budget rules are interesting legal precedent. The State of Illinois, while I was watching, simply delayed payments, often by years. It paid its bonds on time. That isn't a good outcome of course, but it represents the State's choice of how to handle the legal requirement to pay vendors and to pay interest and principal on bonds. Other states have defaulted as have cities and counties. And countries. 


Now for fun. Just print money, some say. Fortunately, our legal system is full of mechanisms to prevent the government from printing money instead of borrowing it. The treasury has to issue debt; the Fed has to buy it,  and thereby give the Treasury new money to spend.  That violates the debt limit. But Treasury can create coins. So, last time, the fun suggestion of $1 trillion dollar coins came up. 

Here is a novel proposal in the same sprit. The debt limit is calculated based on face value, not market value of debt. A bond promising $100 in 10 years and $3 coupons from now to then counts as $100 of debt. So issue perpetuities. Or, more realistically, issue coupon only debt.  The government could issue a bond that pays a $3 coupon for 30 years and no principal payment. As things are now calculated, that bond adds zero to the debt! 

Like the trillion dollar coin, this proposal so clearly violates the spirit of the debt limit that I doubt serious people would do it. It does point to a serious shortcoming in how the Treasury calculates debt however. Most of the time Treasury issues debt at par, borrowing $100 and promising to repay $100 in 10 years. Then the distinction does not matter. But the formulas should be fixed. 

Disclaimer: I'm not an expert on the law of the debt limit. If these points are in error, let me know and I'll issue a "never mind." 


To clarify, this is just a fun way to get around the debt limit if one wants a fun way to do it. It's not obvious that getting around the debt limit is a good idea. What is the justification for running primary deficits right now? No, I'm not a balanced budget nut. In times of crisis, war, pandemic, and recession, the government should borrow, for standard tax-smoothing reasons. But then the government should repay the debt. When the economy is humming and there is no crisis on, we should be running small steady primary surpluses. That is now. One has to argue that yes, we should get there, and stop borrowing in good times,  but it's too hard to do all of a sudden. But just what are those adjustment costs? A crisis is a terrible thing to waste. Today is as good a day as any to clean up the US long term fiscal mess. It's not clear to me that Washington does anything better if it takes a long time to do it. 



  1. John, I think this observation is very important:

    > The government will violate the debt limit no matter what it does.

    Exactly. The government would wind up with inconsistent legal mandates: to spend on X (bond payments), to spend on Y (social security), and to not borrow.

    Why does everyone assume that in that case, the government would honor "not borrow" and default on some spending commitment? Generally, when laws are logically inconsistent, doesn't the most recent law take priority? Aren't the spending bills newer than the prohibition against borrowing? Shouldn't the law conflict be resolved in favor of borrowing and spending --- from a moral, legal, and practical point of view? Why does everyone assume that the older law (prohibition on borrowing) would preempt the newer law (spending bills)?


    1. The "spending bill" is an appropriation of government revenues without a time limit attached to it. The timing of the expenditure of the appropriated funds is discretionary. It is not contractual unless the appropriation is related to a government contract for supply.

      Payment of interest and principal on bills, notes, and bonds is contractual. Insolvency is a hard default, which as John notes, raises the question of the creditworthiness of all U.S. obligations and will, as past events have shown, will lead to credit downgrade by the rating societies that in turn will make it more difficult for the federal and state governments to raise operating funds in the financial markets.

      Needs must, but some needs are more important than others.

    2. I used to accept the anti-debt-ceiling trope that the debt ceiling was fundamentally unfounded because the debt was the sum of all appropriations over time, minus the sum of all taxes levied.

      I stopped believing this when the Executive Branch started spending money in industrial quantities, culminating most recently with the forgiveness of almost a trillion dollars of student loans [which is tied up in the courts, but which may already constitute an instantaneous increase in the debt because it evaporates a class of asset], and the even larger change in student loan terms that decreases interest, decreases the discretionary income which reduces the payments, and makes income based repayment forgiveness occur sooner than before the executive action.

      Article 1 Section 8 of the constitution gives Congress the power to incur debt, but spending money in the executive branch violates that without any corresponding congressional action.

    3. If one takes as a definition, {Debt} = {Sum of Appropriations} minus {Sum of Federal Receipts}, then {Debt} = {Debt, issued & outstanding} as at time t, plus {Debt, yet to be issued} for time in the interval [t, infinity) on the real line R(-infinity, infinity) because not all appropriations have been expended and not all federal receipts have been received. Nevertheless, the definition fits the circumstance where a sitting president issues a 'debt forgiveness' executive order on his own cognizance. However, the sitting president who issues such an executive order has not incurred a debt meeting the definition of Art. 1, s. 8, presumably. He has simply ordered the cessation of collection efforts by his administration. The next administration can reverse the previous administration's executive order(s), and resume collection of the indebtedness. If Art. 1, s. 8, holds viz. the issuance of debt, then should it not also hold viz. the forgiveness of debt as well? If so, then the executive order forgiving debt is null, a.s.

  2. Have you ever seen anything about the 14th amendment line about questioning the validity of debts be used to force the Treasury to prioritize interest/principal payments over others? If so, could that argument hold up?

  3. Matt Levine suggested something similar a week ago: "Treasury sells you one one-year $100 bond today, with an interest rate of 109%. In a year you get back $209: the $100 face amount of the bond, plus 109% interest." See here:

    1. I read Levine's article, and i couldn't make heads or tails out of it. I think Mr. Cochrane's explanation is much clearer.

  4. Cato has an article on
    "Can Federal Assets Cover the National Debt?...JUNE 29, 2020 ...
    Selling all of these resources will cover, at most, 14 percent of the national debt as it stood last week, and probably a lot less."

    Even if it wouldn't cover the debt: it could cover payments on it for a while. Of course unfortunately realistically they'll never even consider that as an option.

  5. 14th Amendment? Fourteenth Amendment, Section 4:

    The validity of the public debt of the United States, authorized by law, including debts incurred for payment of pensions and bounties for services in suppressing insurrection or rebellion, shall not be questioned. But neither the United States nor any State shall assume or pay any debt or obligation incurred in aid of insurrection or rebellion against the United States, or any claim for the loss or emancipation of any slave; but all such debts, obligations and claims shall be held illegal and void.

    Although Section 4 "was undoubtedly inspired by the desire to put beyond question the obligations of the government issued during the Civil War, its language indicates a broader connotation. . . . '[T]he validity of the public debt'. . . [embraces] whatever concerns the integrity of the public obligations," and applies to government bonds issued after as well as before adoption of the Amendment

  6. what is the enumeration of statements and your evaluation?

    1. "Failing to increase the debt limit would have catastrophic economic consequences." True
    2.a. "It would cause the government to default on its legal obligations..." False
    2.b. " unprecedented event in American history." False
    3. "That would precipitate another financial crisis and threaten the jobs and savings of everyday Americans – putting the United States right back in a deep economic hole, just as the country is recovering from the recent recession." True

    1. If 2.a and 2.b are false, then 3 is false; and, by extension, 1. is false.

    2. Not so. The plausible threat of a default (as the result of failing to increase the debt limit) could easily "precipitate another financial crisis" (3 is true), even if a similar default has happened before (2b is false) and doesn't actually end up happening this time (2a is false).

  7. There will come a day when the debt ceiling is fixed at a nominal dollar amount for all time to come. How do we know this? Assume the FTPL is true. It follows from the FTPL that if the price level is bounded then the present value of government debt is positive which implies that the market expects the government to run primary surpluses sufficient to retire those obligations. Assume that the FTPL is false. If the present value of government debt is positive, then the market expects that the government will run primary surpluses sufficient to retire those obligations. In the former instance, the expectation refers to real (constant purchasing power) value debt. In the latter instance, the expectation is more likely to be true for nominal value debt and an unbounded price level.

    The U.S. is not about to be forced to contend with that situation. Raising the debt limitation level is a purely political decision that will be made in due course, a.s. Those opposed to raising the debt limitation level are in the minority. Ergo, the result is a foregone conclusion. But in the theater of the absurd, it is play that is the draw -- not the outcome.

  8. "The second statement is false. The US has defaulted on gold clauses in the 1930s."

    You are most correct. i have pointed this out on several occasions.

    Anyone who thinks that the courts will protect you from an abusive government. needs to understand how egregiously they failed on this occasion.

  9. Such total nonsense on the part of the Grump. The US government debt is not a problem in any way shape or form. In fact, it can be repaid tomorrow without a negative repercussion. That would simply involve replacing government bonds with deposits at the Federal Reserve Bank with similar interest and maturities. The similar or even better risk/reward terms assure no change in investor savings/spending preference or desire to hold dollars. What a Grump!

  10. Issuing the $100 Trillion Coin solves the problem. If folks want to eliminate the deficit, they can legislate it. The ultimate solution is the Job Gty. The constraint is the productive capacity of the economy, as measured by wage inflation. If prices do rise above an acceptable level, they can be controlled by i) selling government securities, ii) raising interest paid on deposits at the fed, iii) raising taxes across the board (on income, sales/vat, and asset values), or iv) a cut in spending.

    Regarding Fiscal Policy, for example, the Job Gty/Green New Deal law should include AUTOMATIC across-the-board tax increases that kick in when certain monthly wage inflation target are hit - say for 6 months in a row. These can include:
    a) Income Taxes,
    b) Sales/VAT Taxes
    c) Asset Value (or Wealth) Taxes
    That'll cool things off pronto.

  11. I like the idea of perpetual debt. P{perhaps because I proposed something similar in the UK. I urged the government to issue a special set of 'pandemic bonds' to pay for COVID-related expenditure; and that these would be what we here call consols, i.e., no redemption date (hence perpetual) but redeemable at the discretion of the issuer.

  12. Janet, Just withhold SS payments first. See how fast they make an agreement.

  13. Couldn't the Treasury *literally* print money? Or would this somehow be different than the infamous $1 trillion coin idea?

    1. No. The Fed prints money, not the Treasury. The only money the treasury can "print" is collectible coins, hence the "trillion dollar coin" idea that some people have floated.

  14. Indonesia exploited a version of money financed fiscal programs through the pandemic and evidently with success.

    There seems to be some Macroeconomic Voodoo Orthodoxy that the central bank can print money but that the Treasury should not print money--- although the ideal is that only commercial banks print money (through lending, which is essentially printed money).

  15. The hilarious bit is that the interventionist state demands that CCP’s hold US Treasuries as collateral.

  16. Several years ago when this same issue came up, David Henderson challenged the notion that Social Security benefit payments were in danger of not being made when the debt limit was reached. See

  17. Simple and dumb solution to the debt ceiling: pass a law where it increases by n% a year for 30 years. Then at the end of 30 years, adjust, but too much. Only downside to this is it doesn't take into account the future being somewhat murky.

  18. One little quibble. Since WWII there have been vanishingly few periods when the Federal government ran a primary surplus. Yet the federal debt as a share of GDP shrank when the annual Federal deficit as a % share of GDP was kept below the annual % growth rate of GDP.


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