Throughout modern history, the U.S. has never defaulted on its debt. The government has a self-imposed borrowing limit known as the debt ceiling, and over time, it has raised or suspended that limit to help prevent the U.S. from defaulting on its debt.
The debt ceiling was reached once again on Aug. 1, 2021, the day after the suspension that was put in place by the Bipartisan Budget Act of 2019 expired. Congress must come to an agreement on whether to raise it again or suspend it to prevent default. Not raising or suspending the debt ceiling could potentially lead to volatile financial markets and a recession.
The debt ceiling is the limit on how much debt Congress allows the federal government to have. On Aug. 1, 2021, that limit was $28.4 trillion. If the ceiling was never raised or suspended, the U.S. Treasury Department would not be able to issue more Treasury bonds, which bring in revenue to help pay bills. The government would be forced to choose between paying federal employee salaries, Social Security benefits, or the interest on the national debt. If it doesn't pay that interest, the country would default.
On Dec. 14, 2021, the debt ceiling was raised once again, by $2.5 trillion—the new limit is around $31.4 trillion.This increase constituted the largest dollar amount increase of the national debt.
- In modern history, the U.S. has never defaulted on its debt.
- The debt ceiling is the self-imposed limit on how much debt Congress allows the federal government to have.
- If Congress does not raise or suspend the debt ceiling, the U.S. could default on its debt, which would also impact financial markets and the economy.
Two Ways the U.S. Could Default on Its Debt
There are two ways the U.S. could default on its debt: not raising or suspending the debt ceiling and not paying interest on Treasury bills, notes, and bonds.
Not Raising or Suspending the Debt Ceiling
The U.S. could default on its debt if Congress doesn't raise the debt ceiling once it’s reached. Congress also has the power to suspend the debt limit, as it did in 2019 with the Bipartisan Budget Act.
When the debt ceiling is reached, the Treasury Department takes various emergency financial measures to help pay the nation’s bills, buying some time for Congress to make a decision on the debt ceiling. However, those measures can only last so long.
In a statement on Oct. 6, 2021, Treasury Secretary Janet Yellen stressed the urgency of raising or suspending the debt ceiling as a way to prevent default.
“Treasury is on the cusp of exhausting its extraordinary measures if Congress has not acted to raise or suspend the debt limit,” Yellen said. “After that point, we expect Treasury would be left with very limited cash that would be depleted quickly.”
When a decision on raising or suspending the debt ceiling is delayed, businesses and consumers often lose confidence in the nation, which could lead to higher interest rates, uncertainty in the financial markets, and a downgrade of the U.S. credit rating.
U.S. debt has been seen worldwide as a safe investment. Most investors look at Treasurys as if they were 100% guaranteed by the U.S. government. Any threat of default could cause debt rating agencies, such as Moody's and Standard and Poor's (S&P), to lower the U.S. credit rating, and that could impact the stock market. For example, in April 2011, the S&P only lowered its outlook on the U.S. debt from AAA (extremely strong) to AA+ (very strong), yet the Dow Jones Industrial Average immediately dropped 140 points.
Not Paying Interest on Treasurys
The second way the U.S. could default on its debt is if the government simply decided that its debt was too high and it stopped paying interest on Treasury bills, notes, and bonds. In that case, the value of Treasurys on the secondary market would plummet.
Anyone trying to sell a Treasury would have to sell it as a deep discount. The federal government could no longer sell Treasurys in its auctions, either, so the government would no longer be able to borrow money from investors to pay its bills.
How a U.S. Debt Default Could Impact the Economy
A U.S. debt default is much more than the federal government just needing to finally pay its debt. It would greatly impact the economy and people in the U.S.
A default would increase interest rates, which could then increase prices and contribute to inflation.
The stock market would also suffer, as U.S. investments would not be seen as safe as they once were, especially if the U.S. credit rating was downgraded.
Several government programs like Social Security and Medicare would all be impacted, too. Military wages and even small business owners with federal loans would be at risk in the event of a default. Federal employees wouldn’t be paid and parents expecting a Child Tax Credit payment would get nothing.
These financial impacts would have a major effect on consumer spending and businesses could shut down. Eventually, the U.S. could enter another recession as a result.
The U.S. isn’t the only country to come close to defaulting on its debt. Greece is working to repay its debt after the European Union helped it avoid default in 2010, and Iceland actually did default in 2009, and banks collapsed as a result.
How Can the U.S. Avoid Defaulting on Its Debt in the Future?
Treasury Secretary Yellen said in an October 2021 statement that a U.S. debt default is “unnecessary” and must be avoided.
“We are staring into a catastrophe in which we surrender this hard-earned reputation, and force the American people, and American industry, to accept all the pain, turmoil, and hardship that comes with default,” she wrote.
The simplest way to avoid an immediate default on its debt is for Congress to raise or suspend the debt ceiling.
One way to potentially avoid the U.S. defaulting on its debt is to increase revenue through higher taxes and spending cuts. This could help the U.S. government make more money to pay down its debt. The U.S. did this in the 1990s, and between a series of tax increases, defense spending cuts, and an economic boom, the U.S. saw four years of a budget surplus that it hadn't seen in 40 years. That helped reduce the national debt and prevent default.