Why the US is always hitting a "debt ceiling"

Summary

This script explores the concept of credit ratings for both businesses and countries, using Microsoft and Tesla as examples to illustrate how these ratings affect interest rates. It delves into the United States' debt ceiling, its political implications, and the potential consequences of hitting that limit. The discussion also touches on the US national debt, its comparison to the economy's size, and the Treasury's role in managing it. The video ponders the impact of debt on the economy, the importance of how and when debt is incurred, and the potential risks of default. It concludes with a critique of the US debt ceiling and suggestions for reform, emphasizing the importance of political stability for economic health.

Takeaways

• 🏢 Credit ratings for businesses are based on their ability to repay debts, with Microsoft holding the highest AAA rating.
• 🚀 Newer companies like Tesla have lower credit ratings, such as BB, which affects their borrowing costs and interest rates they pay to investors.
• 💼 The riskier a company's credit rating, the higher the interest rate it must pay on its debts.
• 🌎 Countries also have credit ratings, with the United States once having a AAA rating but facing downgrades due to political risks and debt ceiling issues.
• 💵 The US has a debt ceiling, a limit on how much debt the country can accumulate, which has led to political standoffs and near defaults.
• 📉 The US national debt is at an all-time high, nearing 29 trillion dollars, and is managed by the US Treasury, which funds government operations through tax collection and bond sales.
• 💼 More than a third of US bonds are owned by Americans and American entities, with foreign investors holding a smaller portion.
• 💸 The pros and cons of debt are complex, with borrowing being beneficial during economic downturns but less advisable during periods of economic strength.
• 📈 Low interest rates have made it easier for countries like the US to sustain borrowing, but the potential for rates to rise poses risks.
• 🚨 A US default on its debt, while unprecedented, could lead to a rise in interest rates across the board, affecting everything from mortgages to credit cards, and potentially causing economic instability.

Q & A

What are the purposes of credit ratings for businesses?

Credit ratings for businesses indicate how likely a company is to pay back its debts. A higher rating, like AAA for Microsoft, suggests a lower risk and a history of timely payments, while a lower rating, such as BB for Tesla, suggests a higher risk and may affect their interest rates.

How do interest rates relate to a company's credit rating?

The riskier the credit rating, the higher the interest rate the company must pay on its debts. This is because investors demand higher returns to compensate for the increased risk of non-payment.

Why do countries have credit ratings, and what is the significance of the US's AAA rating?

Countries have credit ratings to assess their ability to repay borrowed money. The US's AAA rating signifies a very low risk of default, which historically has been a strong indicator of economic stability and trustworthiness.

What is the debt ceiling, and why is it significant for the US economy?

The debt ceiling is a legislative limit on the amount of national debt the US government can accumulate. It is significant because if the limit is reached, the government may not be able to borrow more money, which could lead to a default on its loans and potentially cause economic turmoil.

How has the US's approach to the debt ceiling changed over time, and what were the consequences of the 2011 downgrade?

The US has had to raise the debt ceiling multiple times to accommodate its growing national debt. The 2011 downgrade was a significant event as it was the first time the US lost its AAA rating due to political risks, signaling a potential instability in the country's financial management.

What is the role of the US Treasury in managing the national debt?

The US Treasury is responsible for collecting taxes and spending them to fund the government. When the government spends more than it collects in taxes, the Treasury issues bonds to cover the difference, effectively taking on debt.

Who are the major holders of US debt, and how does this ownership structure affect the economy?

More than a third of US bonds, and thus the national debt, are owned by Americans and American entities such as investors, banks, local governments, and pension funds. The federal government also owns part of its own debt, including funds for Social Security and federal pensions. Foreign investors hold about a quarter of the US debt, with Japanese investors currently owning more than Chinese investors.

What are the potential consequences of the US hitting the debt ceiling?

If the US hits the debt ceiling, the Treasury would not be able to issue more bonds, leading to a halt in debt revenue. This could force the government to stop paying federal employees or funding programs, and eventually default on its debt, which could significantly increase interest rates and harm the economy.

Why is the debt limit considered a problem, and what are the arguments for and against its existence?

The debt limit is considered a problem because it can lead to political gridlock and economic uncertainty. Arguments for its existence include the need for fiscal responsibility and oversight, while arguments against it suggest that it's contradictory and unnecessary, as Congress and the President can control debt by adjusting tax and spending policies.

How does the US's debt situation compare to other developed countries, and what are the implications?

The US has the fourth-largest debt compared to the size of its economy among developed countries. This can have implications for investor confidence and the cost of borrowing, as well as the overall stability of the global financial system.

What are the potential long-term effects of political dysfunction on the US's financial reputation and investment attractiveness?

Political dysfunction can erode investor confidence and make the US a less desirable place to invest, potentially leading to higher borrowing costs and slower economic growth. This could undermine the US's historical advantage as a safe investment destination.

Outlines

00:00

📈 Understanding Credit Ratings and National Debt

This paragraph introduces the concept of credit ratings, which are used to assess the ability of businesses and countries to repay their debts. It uses Microsoft and Tesla as examples to illustrate how credit ratings impact interest rates. The paragraph then transitions to discuss the United States' credit rating and its debt ceiling, which is a legislative limit on the amount of national debt the country can carry. The potential consequences of hitting the debt ceiling are explored, including the risk of default and the political implications of frequent debt ceiling adjustments. The narrative also touches on the historical context of the US debt ceiling and the impact of political decisions on the nation's credit rating.

05:01

🏛️ The Politics and Economics of the US Debt Ceiling

The second paragraph delves into the political and economic aspects of the US debt ceiling. It contrasts the US's approach with that of Denmark, which has a debt ceiling set so high that it is not a constraint. The paragraph discusses the inherent contradictions in the US system, where the government authorizes spending and taxation levels that necessitate borrowing, yet has a law restricting that borrowing. The potential outcomes of reaching the debt ceiling are examined, including the inability to issue new bonds, the risk of default, and the broader economic repercussions such as rising interest rates and job losses. The paragraph concludes with a critique of the current system and suggestions for reform, such as abolishing the debt ceiling or setting it at a level that does not threaten the economy, and emphasizes the importance of political stability for maintaining investor confidence in US debt.

Keywords

💡Credit Rating

A credit rating is an assessment of the creditworthiness of a company or a country, indicating the likelihood that it will repay its debts. In the video, Microsoft is given an AAA rating, the highest possible, due to its consistent history of timely debt repayment. This contrasts with Tesla, which has a lower BB rating, reflecting its relatively higher risk. Credit ratings are crucial as they influence the interest rates companies pay on their debts, with riskier entities like Tesla having to offer higher interest rates to attract investors.

💡Interest Rates

Interest rates are the percentage of a loan that a borrower pays to the lender, reflecting the cost of borrowing. The video explains that Microsoft, with a better credit rating, pays its investors a lower interest rate of 2.5%, while Tesla, being riskier, pays a higher rate of 5.3%. This illustrates how credit ratings directly impact the borrowing costs for businesses, with higher risk associated with higher interest rates.

💡Debt Ceiling

The debt ceiling is a legislative limit on the amount of national debt a country's government can accumulate. The video discusses the United States' debt ceiling, which has been a point of contention and political negotiation, as it limits the government's ability to borrow money to fund its activities. The video highlights the tension when the US nearly failed to raise the debt ceiling in 2011, leading to a downgrade in its credit rating due to perceived political risks.

💡National Debt

National debt refers to the total amount of money a country owes, both domestically and internationally. The video presents the US national debt nearing 29 trillion dollars, emphasizing its significance relative to the size of the economy. It also discusses how the debt is managed, with the US Treasury playing a central role in collecting taxes and issuing bonds to cover spending that exceeds tax revenue.

💡Bonds

Bonds are debt securities issued by entities such as governments or corporations to raise capital. In the video, the US Treasury is described as issuing bonds to fund government operations when tax revenue is insufficient. The script provides an example of a $1,000 bond with a 2% interest rate, where the investor receives $20 annually and the principal after 30 years. Bonds are a significant part of the US debt, with various entities, including Americans, owning them.

💡Federal Reserve

The Federal Reserve, often referred to as the Fed, is the central banking system of the United States. It plays a critical role in the economy by influencing monetary policy, including interest rates. The video mentions that the Federal Reserve holds bonds, which are part of its toolkit for managing the money supply and influencing economic conditions.

💡Foreign Investors

Foreign investors are entities or individuals from outside the country who invest in that country's financial instruments, such as bonds. The video notes that foreign investors own about a quarter of the US debt, with Japanese investors now holding more US debt than Chinese investors. This highlights the global nature of financial markets and the reliance of countries like the US on international investment.

💡Economic Recession

An economic recession is a period of negative economic growth, typically characterized by a decline in GDP, high unemployment, and reduced industrial production. The video suggests that it is appropriate for countries to borrow more during recessions to stimulate the economy. This is contrasted with borrowing during periods of economic strength, which can be less justifiable and more risky.

💡Default

Defaulting on debt means failing to make required payments on the borrowed money. The video discusses the severe consequences of the US defaulting on its debt, which has never happened. It explains that a default would lead to higher interest rates, increased borrowing costs for all types of loans, and potential economic instability.

💡Polarization

Polarization refers to the division of a group or society into opposing factions with little agreement or compromise. In the context of the video, political polarization in the US is highlighted as a factor contributing to the difficulty in managing the national debt and the debt ceiling. The video suggests that this polarization could undermine the US's attractiveness as an investment destination.

💡Investment

Investment in the video refers to the act of putting money into financial assets, such as bonds, with the expectation of earning a return. The video explains how the US Treasury's bonds are considered safe investments, which has historically made the US a desirable place for investors. However, it also raises concerns that political dysfunction could erode this perception and affect the US's economic advantages.

Highlights

Grades are assigned to businesses based on their debt repayment likelihood.

Microsoft has the highest AAA grade due to its consistent on-time payments.

Tesla has a BB rating, reflecting its newer status and different business model.

Interest rates are higher for riskier grades, with Microsoft at 2.5% and Tesla at 5.3%.

Countries also have credit ratings, with the US once having a AAA rating.

The US debt ceiling is a limit on national debt, which has been a point of political contention.

The US was downgraded in 2011 for the first time due to political risks.

The US national debt is nearing 29 trillion dollars, a significant figure compared to the economy.

The US Treasury manages the national debt through bond sales to fund government spending.

More than a third of US bonds are owned by Americans, including the federal government itself.

Japanese investors now hold more of the US debt than Chinese investors.

The US has the fourth largest debt compared to the size of its economy among developed countries.

The impact of debt is complex, with both pros and cons depending on its use and interest rates.

The US debt limit is internally contradictory, causing political and economic stress.

Hitting the debt ceiling could lead to the US defaulting on its financial obligations.

A default would significantly increase interest rates and have broad economic repercussions.

The debt limit could be managed better or repealed, as it is in most other countries.

Political dysfunction around the debt limit could undermine the US as a safe investment.

Transcripts

These grades aren’t for students.

They’re for businesses.

Based on how likely the company is to pay its debts back.

A company like Microsoft has the best grade possible: AAA.

Since they have a long history of paying people on time.

"The Internet is about driving profitability."

But a newer company like Tesla, has a BB rating.

"Fundamentally changed the equation."

"You've got to have an all electric vehicle."

And that affects their interest rates.

Microsoft pays its investors 2.5%.

Tesla pays a bit more at 5.3%.

The riskier the grade, the higher the interest rate.

But it’s not just companies that have grades: countries do, too.

The United States, for a really long time, had a AAA rating.

Until...

“Lawmakers have just two days to raise the nation's debt ceiling and avoid a catastrophic--"

“Default on its loans, which could create turmoil in the US economy and worldwide.”

The US has a weird thing called “the debt ceiling” which is just a limit

on how much debt the country can take on.

If the national debt reaches that limit, the US might not be able to pay its investors.

The US regularly comes close to hitting it

but the government always ends up raising it.

Until 2011, when it almost didn’t.

After that, the US was downgraded by a credit agency for the first time, due to quote

“political risks.”

Since then, Congress and the president have had to raise it 7 more times.

It’s becoming an almost annual task.

And of course, it always goes super swell….

"The entire basis of the Republican strategy is we're gonna shut down the government

or cause economic chaos if we don't get 100% of what we want."

"This isn't some damn game!"

"My Republican friends need to stop playing Russian roulette--"

"Russian roulette with the economy."

In the last 20 years, the US has borrowed more and more money.

The national debt is at an all-time high.

But how should we feel about this debt?

And what happens if we don’t pay it back?

The US national debt is nearing 29 trillion dollars, with a capital T.

Depending on when you watch this, it might already be there.

It’s best not to look at it as a number

but instead as a comparison to the size of the economy.

You’ll see the US takes on more debt when the country spends a lot: because of wars,

or because of investments needed during recessions and… now, pandemics.

And the department in charge of all this is the US Treasury.

They collect taxes and spend them to fund the government.

And, for the record, it's Congress and the President who decide how much taxes should

be, and where the money should be spent.

The Treasury just handles the flow of money.

But for—essentially, ever—they approve more spending than they bring in with taxes.

So the Treasury has to make up that difference by taking on debt.

And it does that by selling bonds.

They can vary, but generally it works like this:

You buy a $1,000 30-year bond at a locked-in 2% interest rate.

Every year the Treasury sends you $20, the 2% interest you’ve earned.

And after 30 years, you can cash out the bond and get your $1,000 back.

It’s a win-win situation.

The US gets money to fund the government and you make some profit on a safe investment.

More than a third of these bonds — and therefore the total US debt — are owned by Americans

and American companies.

Investors, and also banks, local governments

and even pension funds keep their money in bonds.

And the largest part is owned by the federal government.

Yes, the federal government owns part of the federal government’s debt.

The money for Social Security is actually kept in bonds.

So is the money for Medicare.

And federal pensions.

The Federal Reserve has bonds, too.

Foreign investors only own a quarter of the US debt.

And while Chinese investors used to have the largest share

Japanese investors actually own more now.

They own around 4% of all US debt.

And it is a lot of debt.

Of all the developed countries, the US has the fourth largest debt

compared to the size of the economy.

So is this… bad?

The really, really frustrating answer is we don't know.

Debt has pros and cons.

One question is what are you doing with the debt?

When you're in an economic recession or an emergency not only should you borrow

you should borrow a lot.

But what you shouldn't do is borrow when your economy is strong and the political inconvenience

of paying for things is too high.

Another really important question is what are interest rates?

FURMAN: In recent years, interest rates have been very low.

FURMAN: That tends to make it easier to borrow and to sustain that borrowing.

FURMAN: Where we are now doesn't make me, as of now, very nervous.

I worry about the debt a lot more than he does.

While all countries take on debt, only these two have debt ceilings.

Denmark’s, however, is kept so high they’re not going to come close to hitting it.

Unlike the United States, where the government is constantly having to raise the debt ceiling

to pay for spending they already approved.

That’s the big problem with the debt limit, is it's internally contradictory.

FURMAN: The government passes a law that says you have to spend 10.

It passes a law that you can only collect 8 in taxes and then it passes another law

saying you're not allowed to borrow 2.

If the US does hit the debt ceiling, it would mean the Treasury couldn’t issue any more bonds.

So, no more debt revenue.

Taxes would still be coming in, but that’s not enough to cover all these responsibilities.

So maybe they stop paying federal employees.

Or stop sending money for programs.

But at some point, they won’t be able to pay the interest to these investors

or cash out Social Security bonds.

That’s called a default.

It’s never happened...

yet.

You couldn't do more to sabotage your financial system than default.

Interest rates could rise based on a reassessment that the United States was considerably riskier

than people had thought before.

When government bond interest rates go up, that usually means that other interest rates

are going up.

If you borrow for anything, whether it's for a dishwasher, or a car, college, or your credit

card, that's going to become more costly.

We're going to lose jobs.

Wages won't go up as high.

We could be like these countries and just not have a debt limit.

Or have one so high it’s never a threat to the economy.

Because if Congress and the President really want to take on less debt

they can change the tax system.

Or reduce spending.

The debt limit does make sense if you are a functioning Congress, you're saying we need

to put in place some policy to make sure that we don't borrow more than we mean to

or we stop and we pause and we check on the borrowing.

That certainly isn't how it is working.

The simplest thing would just be to repeal it

and be like almost every other country in the world.

Even if the US never actually defaults on its debt, just the mere political fights and

“will they or won’t they” unease could make the United States

a less desirable place to invest.

It's long been seen as this kind of the safest asset that you can invest in, and so

that's given the U.S. a lot of advantages.

But the more our political system is so polarized and dysfunctional, the more that it becomes

a little bit questioned of whether the US should have the incredible advantage

that it has thus far.