In-depth analysis of the US debt ceiling

Translation from TBAC report materials to the U.S. Department of the Treasury:

P1 Home Overview

"Since 1960, Congress has acted 78 times to raise or suspend the statutory debt ceiling. Concerns over the debt ceiling—and the procedures involved in raising or suspending that limit—have led to increased borrowing costs for the Treasury, disrupted financial markets, and resulted in a downgrade of the U.S. sovereign credit rating. In December 2024, the Government Accountability Office (GAO) released a report highlighting the serious consequences of a potential default and reiterated three alternatives for improving the debt ceiling process:"

(1) Link the debt ceiling to the budget process;

(2) grants government management departments the authority to raise the debt ceiling under the condition of a motion of opposition presented in Congress;

(3) Abolish the debt ceiling to allow the Treasury to borrow the necessary funds as authorized by law to cover expenditures.

We hope the committee will provide its opinion on the impact of the debt ceiling (and related processes for raising or suspending it) on the financial markets. At the same time, please consider the options proposed by GAO and their potential benefits and costs.

P2 Summary

➢ The current debt ceiling policy has had various negative impacts on the global financial system.

➢ The debt ceiling has not effectively constrained the level of national debt; in fact, in recent years it has often been used as a bargaining chip in political negotiations.

➢ The negative impacts on the financial system include: rising debt service costs, downgrading of credit ratings, increased risk of technical defaults, turmoil in financial markets, and loss of productivity.

➢ It is necessary to reform the current practices to some extent, along with a commitment to sustainable fiscal prospects and governance mechanisms.

➢ The market may welcome reforms that can both reduce the risks of political edge play and maintain a certain level of oversight over national debt.

Review of the Current Debt Ceiling Process P3-P6

➢ The debt ceiling refers to the total amount of money that the U.S. government is authorized to borrow to meet its existing legal obligations.

➢ The debt ceiling applies to the total debt disclosed, rather than being limited to the net debt held by the public.

➢ As of March 2025, the government's internal debt is approximately $7.2 trillion (accounting for 20% of the total debt).

➢ Congress establishes a process for setting the debt ceiling that is independent of spending decisions; it merely limits the borrowing capacity of the Treasury and the execution of spending decisions.

➢ In theory, the debt ceiling should promote fiscal responsibility; however, in practice, it has recently been used more as a bargaining chip, which is also related to increasing political polarization.

➢ This situation may increase the costs for taxpayers.

What happens when the debt ceiling is reached?

Left block: If Congress fails to raise or suspend the debt ceiling,

Intermediate block: For example, the Treasury will draw on the Treasury Cash Account (TGA), adjust investments (such as CSRDF, G Fund, ESF),

The right block: The government will face funding exhaustion, thus posing a default risk.

Although the debt ceiling itself has been used as a political tool, it is sometimes linked to the budget appropriation process, which increases the complexity and interplay related to government shutdowns.

➢ The Government Accountability Office (GAO) reviewed the recent debt ceiling impasse, showcasing the duration of the stalemate and the situation regarding the approaching estimated "deadline" (x-date), many of which are very close.

➢ Missing the estimated "deadline" is detrimental to market operations and may increase costs for taxpayers.

➢ Historically, the debt ceiling has always been temporarily raised or suspended.

➢ In terms of the ratio of (debt) GDP, it fell to a low of 30% in the 1980s, and has now reached 132%.

The chart below shows the absolute amount of the debt ceiling since 1945 (in trillions of dollars), while another shows the proportion of the debt ceiling to GDP. The broken blank sections in the chart represent past Congressional measures to suspend the debt ceiling.

Left image: US Debt Ceiling (trillions)

Horizontal Axis: Year (from 1945 to 2025)

Vertical Axis: Absolute Amount of Debt Ceiling

Blank area: Indicates that no specific value has been set for the debt ceiling during the pause measures.

Right image: The ratio of the US debt ceiling to GDP

Horizontal Axis: Year

Vertical axis: Percentage of debt ceiling to GDP

The blank area in the image also indicates the period during which the debt ceiling is temporarily suspended.

P7 The negative impact of the current debt ceiling process

The negative impact of the current debt ceiling practices

➢ We have observed several negative effects of the current debt ceiling strategy:

1 The volatility of the treasury cash account balance, live broadcast room, and short-term government bond issuance has increased.

2 Debt service costs rise

3. Have a negative impact on the credit rating of the United States

4. Adverse impact on the status of the U.S. as a reserve asset

5 The risk of technical default increases

6. Waste of resources in the public and private sectors

P8 Impact #1: Increased Volatility in Treasury Cash Account and Short-term Debt Issuance

➢ Significant changes in the Treasury General Account (TGA) can lead to fluctuations in reserve balances, thereby altering the liquidity conditions in the market.

➢ Concerns over the debt ceiling dispute in 2025 may prompt the Federal Reserve to slow down quantitative tightening (QT) earlier than expected, in order to avoid potential market liquidity disruptions caused by the "recharge" of the TGA.

➢ The volatility of short-term bond issuance has increased, which may cause the supply and demand relationship of government money market funds (which hold about 40% of short-term bonds) to become more unstable. Overnight reverse repurchase agreements (RRP) have become a tool that helps reduce risk.

Left Image: Changes in TGA and Reserves

The changes in TGA balance as well as the changes in total reserves and reverse repos are shown, with the shaded area in the chart corresponding to the data situation during the debt ceiling impasse.

Right figure: Chart of the short-term debt holdings and proportions of money market funds.

P9 Continue

➢ The uncertainty of the cash balance of the Ministry of Finance has increased the operational risk of the Ministry of Finance.

➢ The recent debt ceiling impasse has caused the actual Treasury cash balance to fall below the established policy target.

➢ If there is an unexpected cash demand (such as a natural disaster or disruption of market access), this decline will further increase the operational risks of the treasury.

P10 Impact #2: Rising Debt Service Costs

➢ According to a study by the Federal Reserve in 2017, an analysis of the debt ceiling impasses in 2011 and 2013 showed that these impasses could lead to an increase in borrowing costs of approximately $500 million.

➢ Considering that current outstanding debt has grown to over twice (approximately $16 trillion), the cost increase at this stage may far exceed previous estimates.

➢ The research not only observed a significant impact on short-term debt yields but also estimated the impact on coupon bond interest rates.

Impact #3: Negative Impact on US Credit Rating

➢ In 2011, Standard & Poor's (S&P) downgraded the credit rating of the US government from AAA to AA+, and this downgrade was partly due to political brinkmanship:

"The political brinkmanship of recent months has highlighted our growing concerns about the instability, ineffectiveness, and unpredictability of American governance and policymaking. The statutory debt ceiling and the threat of default have become political bargaining chips in the debate over fiscal policy. Despite extensive discussions this year, the divisions between the two parties have proven difficult to bridge, and the agreements reached are far from the comprehensive fiscal tightening level envisioned by some advocates. Congress has only achieved limited savings on certain discretionary spending, while delegating some decision-making authority to special committees. Meanwhile, new sources of revenue have significantly declined in policy choices. The plan has only made minor adjustments to Medicare and has changed little in other key social security programs, which are crucial for ensuring long-term fiscal sustainability."

➢ Recently, in August 2023, Fitch downgraded the U.S. government's credit rating from AAA to AA+. One of the reasons mentioned in the report is "deteriorating governance"—that is, over the past 20 years, the U.S. has continually declined in fiscal and debt management standards, thereby weakening market confidence in the U.S. government's ability to govern.

"Erosion of Governance: According to Fitch, over the past 20 years, even with the agreement reached in June this year to suspend the debt ceiling until January 2025, governance standards (including fiscal and debt issues) have been steadily deteriorating. The repeated occurrence of political deadlock over the debt ceiling and last-minute emergency decisions have eroded confidence in fiscal management. Furthermore, unlike most peer countries, the government lacks a medium-term fiscal framework, and its complex budget process has exacerbated this issue. These factors, along with several economic shocks, tax cuts, and new spending plans, have collectively contributed to a continuous rise in debt levels over the past decade. In addition, progress in addressing the medium-term challenges posed by rising Social Security and Medicare costs due to an aging population has been very limited."

P12 Impact #4: Negative effect on the US reserve status

➢ Further downgrades in credit ratings or concerns about technical defaults may adversely affect the status of U.S. Treasury bonds as a safe and reserve asset, leading foreign buyers to reduce their purchases and turn to other reserve assets (such as gold or foreign government bonds).

➢ If market participants begin to question foreign demand for U.S. Treasuries and foreign investors further reduce their holdings, it may further increase the term premium and raise debt service costs.

Left image: US foreign reserves stopped growing after 2018.

Chart: Gold prices rise (possibly due to reserve diversification)

Right image: Term premium rises

P13 Impact #5: Increased Technical Default Risk

➢ A large amount of research has been conducted to discuss the risks of technical default in detail. The GAO report provides a more comprehensive description of this issue, listing many risk points, including but not limited to:

1. "The complexity of operations may make default unavoidable."

• Even if the debt ceiling can be raised at the last moment in an emergency, the operational complexities may still make it impossible to completely avoid default.

2. "The default emergency plan established to ensure the operation of the market carries risks."

• Involves the discussions in the TMPG white paper,

• Including measures such as extending the maturity date of operations and prioritizing the payment of principal and interest.

3. "Breach of contract may cause serious harm to financial markets and financial institutions."

• May disrupt short-term capital markets and spread to other markets,

• And increase the risk of bank runs.

4. "Default may limit the tools used to protect bank deposits and prevent runs."

5. "Defaulting may reduce loans to households and businesses."

6. "A default could trigger a deep and prolonged recession in the U.S. economy..."

P14 Impact #6: Waste of resources in the public and private sectors

➢ Each time there is a deadlock over the debt ceiling, a significant amount of time and effort needs to be invested in analysis, much of which could have been avoided and redirected towards more productive tasks.

1. Major banks need to conduct various stress tests for the debt ceiling deadlock, involving substantial time and human resources,

• Affect liquidity indicators, margin requirements, and the review of hundreds of credit support agreements;

• And put pressure on the central counterparty (CCP) margin, discount window eligibility, and repurchase facilities.

2. Banks and other investors often sell securities that are due before x date and may be affected by technical defaults,

• To allocate funds to alternative assets such as foreign government bonds;

• At the same time, exclude the affected securities separately in the margin agreement.

3 requires extensive research to estimate very measures, x date, and operational contingency plans,

• For example, the TMPG white paper from 2021 studies the emergency plan for government bond payments,

• Analysis of the complexity of emergency arrangements in payment systems and settlement processes.

P15 Cover Page: Analysis of the Debt Ceiling Alternative Proposed by GAO

Analysis of the GAO Alternative Debt Ceiling Proposal P16

➢ The GAO report reiterated three alternatives for improving the debt ceiling process (as follows):

1. Link the adjustment of the debt ceiling to the budget resolution.

2. Grant the government management departments the authority to raise the debt ceiling under the condition of proposing a motion of opposition in Congress.

3. Authorize government regulatory agencies to have broad borrowing powers in order to finance according to the laws passed by Congress and the President.

➢ In addition, we noted that GAO also released a report in 2020 on "Effective Use of Fiscal Rules and Targets" and recommended integrating these rules into budget decision-making in order to provide a more effective constraint mechanism.

Congress should consider establishing a long-term fiscal plan that includes fiscal rules and targets such as debt-to-GDP ratio goals. In this process, Congress should weigh the key considerations discussed in this report to help ensure that these rules and targets are appropriately designed, implemented, and enforced.

P17 Who holds U.S. Treasuries?

➢ The marginal buyers of government bonds are becoming more price sensitive. When assessing the impact of debt ceiling reforms, more attention should be paid to the investor structure of U.S. Treasury bonds and their possible reactions, rather than just looking at the positions of the holders.

➢ Investors who are more sensitive to technical default risks (such as money market funds and banks) may tend to support reform measures.

➢ Overall, market investors are more likely to welcome measures that reduce the risk of downgrade and improve governance processes.

➢ However, certain groups of investors (such as foreign official holders or American households) may be sensitive to the repeal of this measure, which is seen as a fiscal buffer, and this could affect the term premium.

The overseas holdings of US Treasuries

Country and investor type of US bond investors

The duration of overseas U.S. Treasury holdings

P18 Perceiving Risk: Financial Responsibility

➢ We also note that the timing of debt ceiling reform is crucial. In the current economic environment, the market is particularly sensitive to any measures that are perceived as potentially loosening fiscal discipline.

➢ The publicly held debt of the United States currently accounts for about 100% of GDP, and this ratio is expected to rise to 119% by 2035.

➢ In fact, the debt ceiling has not effectively constrained fiscal spending; therefore, while abolishing the debt ceiling can eliminate various known negative effects, it may also raise concerns about fiscal responsibility from the outside.

➢ In the long term, to strengthen market confidence, any abolition measures are best combined with a credible plan for reducing deficits and controlling spending.

➢ Non-defense discretionary spending only accounts for 14% of income and is expected to drop to 12% by 2035. It may be necessary to consider cutting spending in other categories or adjusting tax policies.

Left chart: Recent CBO budget estimates, Right chart: The proportion of non-defense discretionary spending in total spending.

P19 Alternative 1: Link debt ceiling actions to budget resolutions

➢ Impact on the debt ceiling process:

➢ Limited improvement. Directly linking to the budget process means that the Treasury can ensure borrowing for any funds required by spending laws that have been passed, thus reducing the likelihood of Congress using the debt ceiling as a bargaining chip.

➢ Special consideration needs to be given to how to handle non-annual appropriations expenses, such as debt interest, cost-of-living adjustments (COLA) for social security expenses, etc.

➢ Otherwise, a debt ceiling stalemate may still occur.

➢ According to the data, the borrowing volume in the quarters of 2022, 2023, and 2024 is on average about $74 billion higher than the preliminary estimates by the Treasury, totaling approximately $1 trillion above the estimates.

➢ The impact of external perception on fiscal responsibility:

➢ Limited impact, as the debt ceiling still exists, only tied to the spending process, and Congress still retains control over it.

➢ Impact on the market and investors:

➢ Reforms will bring moderate positive effects and are expected to reduce the frequency of deadlocks.

P20 Alternative Plan 2: Granting government management departments the authority to raise the debt ceiling under the condition of proposing a motion of opposition in Congress.

➢ Impact on the debt ceiling process:

➢ Significant improvements can greatly reduce the phenomenon of Congress using the debt ceiling as a bargaining chip.

➢ Congress can exercise checks on this power by proposing a motion of opposition, but this motion must receive majority support in both the Senate and the House of Representatives; even so, the President has veto power, and overturning a veto requires a two-thirds majority vote in both chambers, making it quite difficult.

➢ The impact on the perception of fiscal responsibility:

➢ It may be seen by some as weakening the existing financial firewall, but the theoretical opposition motion mechanism provides a check against this.

➢ Impact on the market and investors:

➢ Due to the significant reduction in the likelihood of a debt deadlock, the overall market effect tends to be positive; however, at the same time, there may be a moderate negative perception due to some investors' concerns about weakened fiscal control.

➢ This will particularly support the demand for money market funds and banks for short-term government bonds.

P21 Alternative 3: Delegate extensive borrowing authority to government management departments to finance according to the laws passed by Congress and the President.

➢ Impact on the debt ceiling process:

➢ Essentially equivalent to abolishing the debt ceiling, fundamentally eliminating the political deadlock and default risk.

➢ The impact on the perception of fiscal responsibility:

➢ This is the riskiest option among the three plans, as it may be perceived by outsiders as a relaxation of fiscal constraints and controls.

➢ Impact on the market and investors:

➢ Overall, the risk of breaking the deadlock would have a positive effect; however, at the same time, due to concerns from some investors about the potential fiscal risks associated with unrestricted spending, this plan may bring a certain degree of uncertainty in perception.

The positive impact on demand for short-term government bonds (such as money market funds and banks) may be significant, but it is necessary to balance concerns about fiscal discipline.

Case Study P22: Australia

➢ In 2013, to improve fiscal transparency, Australia removed its debt ceiling when its debt exceeded a certain threshold (50 billion USD).

➢ Although no rigorous comparative studies have been conducted yet, data shows that after the suspension of the debt ceiling, both bond yields and term premiums have declined.

➢ However, it is important to note the following three significant differences with the United States:

1. At that time, Australia's debt/GDP ratio was only 30%, much lower than that of the United States;

2. Australian government bonds do not have the status of international reserve assets (lower importance);

3. The size of the Australian government bond market is much smaller compared to that of the United States.

Left image: Australia's debt/GDP ratio was very low in 2013.

The right chart: Yield and term premium have subsequently decreased.

P23 Summary

➢ The current debt ceiling practices have caused various negative impacts on the global financial system and may increase the cost to taxpayers.

➢ In fact, the debt ceiling has not restrained spending; eliminating the debt ceiling could reduce various known negative effects, but in the current economic environment, it would increase market perception risks regarding fiscal responsibility.

➢ It would be ideal if Congress decides to abolish the debt ceiling while introducing a system around fiscal rules and targets (as described in the 2020 GAO report).

➢ Other considerations for future analysis include:

• Should the debt ceiling be quantified as a percentage of GDP;

• With economic growth, the debt ceiling should be raised accordingly;

• Although such changes are not a panacea, they can make fund management smoother;

• In addition, there are some technical issues that need to be resolved (for example, the issue of GDP data revision);

• Should the debt ceiling calculation be limited to debt that is publicly traded in the market?

• Whether the debt held by the U.S. government (such as the debt that supports social security liabilities) can be excluded from the debt ceiling;

• When analyzing debt sustainability or economic conditions, most analysts primarily focus on "publicly held debt," which excludes government internal debt;

• In practice, this will also eliminate certain extraordinary measures involving temporary reductions in internal government debt.

The end of the article.