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Debt Limits, Ceilings & Defaults
I can’t believe I have to write about the debt ceiling again.
It should go without saying that elected officials’ number one job is… you know… ensuring the government doesn’t run out of money. But here we are. Again.
Brief History of the The Debt Limit
People love saying that the United States has never defaulted on its debt (not true, but more on that later). However, the United States was basically founded in default!
When the U.S. Constitution was passed in 1787, there was an air of excitement and endless possibilities in America. However, one man was quickly jolted back to reality: Alexander Hamilton. When he assumed the role of first Treasury Secretary in 1789, things weren’t great:
“Before 1790, the government was effectively bankrupt. Without tax revenues until late in 1789… the U.S. government was in default on almost all of its large domestic debts… as well as on most of its foreign debts…” (Sylla, 2010)
In October 1789, Hamilton even had to sheepishly ask the French government if America could delay paying them back for a few years:
“I venture to say to you, as my friend, that if the installments of the Principal of the debt could be suspended for a few years, it would be a valuable accommodation to the United States… Could an arrangement of this sort meet the approbation of your Government, it would be best on every account that the offer should come unsolicited as a fresh mark of good will.” [Letter from Alexander Hamilton to Lafayette]
In other words, Hamilton wrote Lafayette asking:
On March 29, 1790, Secretary Hamilton had to inform President Washington that some congressional paychecks were about to bounce:
“That, in order to be able to furnish in the course of the ensuing month for the compensation of the members of Congress, & the Officers and Servants of the two houses, a sum of about sixty thousand dollars; for the payment of the Salaries of the Civil List to the end of the present month a sum of about forty thousand dollars; for the use of the Department of War a sum of about fifty thousand dollars; and for procuring bills to pay an arrear of interest on the Dutch Loans to the first of June next, a sum of about thirty five thousand Dollars: amounting together to about one hundred and eighty five Thousand dollars, it will be requisite to obtain a Loan of one hundred thousand dollars, There being in the Treasury now a sum not exceeding fifty thousand dollars…”
The chart below visualizes the dire situation Hamilton communicated to President Washington:
So, from inception, the U.S. government faced an all too familiar issue: too few monies, too many expenses. Also like today, President Washington had to go seek congressional authorization for a new loan to meet government obligations.
This brings us to our topic du jour: The Debt Ceiling.
What is the debt ceiling (limit), exactly?
“The debt ceiling is the legal cap that Congress sets on the amount that the Treasury can borrow. It does not authorize any new spending; it simply lets the government pay for what Congress has approved. The debt ceiling came into being in 1917; before then, Congress tended to authorize borrowing for specific purposes. But when raising money to support America’s entry into the first world war, Congress granted the Treasury more flexibility, eventually setting a comprehensive debt ceiling in 1935.” (The Economist)
Interestingly, before the 1917 shift in policy, Congress authorized the Treasury to issue securities for specific uses like war financing or infrastructure projects. For example, here is the communication President Washington sent Secretary Hamilton regarding the $100,000 loan:
“The Secretary of the Treasury is hereby authorised to negotiate and agree for a Loan to the United States to an amount not exceeding one hundred thousand Dollars, bearing an Interest not exceeding six ⅌. Cent ⅌ annum to be applied towards carrying into effect the appropriation made by the Act Entitled, ‘An Act making appropriations for the support of Government for the year one thousand seven hundred & ninety.’ and according to the annexed representation.”
Washington references the specific Act authorizing Hamilton’s loan.
Between 1776-1920 Congress authorized some 200 of these securities, ranging between 0-8 new securities annually. Importantly, there were “debt limits” for each security being issued. For example, Congress might authorize Treasury to issue $200M of ‘War Bond A’, and $100M of ‘Panama Canal Bond C’.
However, this changed with the onset of World War I, and the introduction of Liberty Loans.
“World War I was a conflict with unknowable costs, making targeted legislation difficult. At first Congress established a $5 billion limit on new issues of bonds, along with the immediate issuance of $2 billion in one-year certificates of indebtedness, in the First Liberty Loan Act of 1917.
But very quickly another law was needed — the Second Liberty Bond Act of 1917 — in which Congress set a general limit on borrowing: $9.5 billion in Treasury bonds and $4 billion in one-year certificates. This freed the Treasury secretary to begin to figure out the best mix of securities to issue, without nearly as much congressional oversight as before.” (Washington Post)
Eventually, in 1939, Congress ditched the limits on individual debt securities, and placed an overall aggregate limit on the national debt. So it was in 1939 that the debt limit (ceiling) we know today, was born.
Now, let’s get some more historical context on sovereign debt defaults, debt limits and more!
Why This is Relevant:
Whenever it comes time for Congress to debate the debt ceiling, politicians are always quick to point out the dangers of United States defaulting for the “first” time in history. However, this is historically inaccurate. In fact, this paper details three instances of default in American history: 1814, 1933, 1979.
“This report examines three episodes in the federal government’s fiscal history when some have questioned the public credit of the U.S. government. During the War of 1812, the federal government eventually became unable to meet its obligations… In March 1933, newly inaugurated President Franklin Roosevelt soon took steps to suspend the gold standard… the cancellation of gold clauses in federal bond contracts amounted to a restructuring of debt… the U.S. Treasury failed to make timely payments to some small investors in the spring of 1979, some dubbed the incident a ‘mini-default’.“
Why This is Relevant:
There has been a warranted focus on the dangers of a national default in the United States, but this paper analyzes the fallout of the Panic of 1837, in which eight states defaulted on their sovereign debts.
“In 1841 and 1842, eight states and the Territory of Florida defaulted on their sovereign debts. Traditional histories of the default crisis have stressed the causal role of the depression that began with the Panic of 1837, unexpected revenue shortfalls from canal and bank investments as a result of the depression, and an unwillingness of states to raise tax rates. This paper shows that none of these stylized facts fits the experience of states at all well. The majority of state debts in default in 1842 were contracted after the Panic of 1837; most states did not expect canal investments to return substantial revenues by 1841 and so could not experience unexpected shortfalls in those revenues; and, finally, most states were willing to raise tax rates substantially. The relationship between land sales and land values explains much of the timing of state borrowing and the default experience of western and southern states. Pennsylvania and Maryland defaulted because they postponed the imposition of a state property until it was too late.”
Why This is Relevant:
This paper chronicles the evolution of sovereign debt over hundreds of years, providing an insightful look at repeating patterns and themes for government debt and defaults. This is a fantastic history of sovereign defaults.
“A key feature of the full sovereign default record from 1294-2008 is that serial default is far rarer than the much-ballyhooed 1980s experience suggests. The only mass default in Europe’s long record, dating back to 1294, occurs during the Napoleonic Wars (1800-1815). The majority of the serial defaults occurred only after 1975, primarily in Africa, Asia, and Latin America, and were heavily concentrated in the 1980s. These countries’ multiple defaults, in common with some earlier default waves in Latin America, reflect the experiences of newer nation states. These defaults also occurred in conjunction with the inherent vulnerability of countries on the periphery to events in the much longer-established major financial centers. This was quite distinct from the earlier defaults seen in Europe and largely represent an aberration when taken in context of the overall historical record both before and after.”
Why This is Relevant:
Kim Oosterlinck is one of the world’s foremost experts on sovereign debt and the history of sovereign defaults. In this paper he analyzes the long history of sovereign defaults in order to better understand the present.
“History provides many insights to address the issue of sovereign debt defaults. This article first presents a detailed account of defaults in historical perspective. It then discusses the solution devised in the past to address sovereign debt crises and sets these into perspective with today’s answers when crises occur. Finally, the paper stresses the role of history when events under study don’t occur frequently and when archival data may add a new light to understand the process of crises resolution. The impact of odious debts declarations, of state succession, and of international relations on sovereign defaults and on their settlement is thus also addressed.”
Why This is Relevant:
This paper provides an excellent history on the historical origins of the American debt limit, which helps us better understand the chaos surrounding debt ceiling crises in modern times.
“Congress has always restricted federal debt. The Second Liberty Bond Act of 1917 included an aggregate limit on federal debt as well as limits on specific debt issues. Through the 1920s and 1930s, Congress altered the form of those restrictions to give the U.S. Treasury more flexibility in debt management and to allow modernization of federal financing. In 1939, a general limit was placed on federal debt. Federal debt accumulates when the government sells debt to the public to finance budget deficits and to meet federal obligations or when it issues debt to government accounts, such as the Social Security, Medicare, and Transportation trust funds. Total federal debt is the sum of debt held by the public and debt held by government accounts. Debt also increases when the portfolio of federal loans expands.”
Why This is Relevant:
While the official debt limit was instituted in 1939 by Congress, limits on the amount of money that America’s government could borrow stretch right back to 1776.
“Congress first imposed an aggregate debt limit in 1939 when it delegated decisions about designing US debt instruments to the Treasury. Before World War I, Congress designed each bond and specified a maximum amount of each bond that the Treasury could issue. It usually specified purposes for which proceeds could be spent. We construct and interpret a Federal debt limit before 1939.”