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Americas

Questioning the 'forced virtue' of debt ceilings

If debt limits are not raised in a matter of days, says the US Federal Reserve, the country will be bankrupt. But why set an arbitrary limit only to break it? And does a "debt ceiling" discourage borrowing at all?

"War is the father of all things" - that line, attributed to Greek philosopher Heraclitus, applies quite well in the case of the current budget dispute in the US. The country's so-called debt ceiling was introduced in 1917 in order to cap the costs associated with entering World War I. The aim was to set a limit on how much debt the US could take on.

If that threshold is surpassed, budget cuts automatically come into effect in order to rebalance the nation's finances. In less than a century, the debt limit has been increased over 75 times. Many have wondered: Does it make any sense to have a limit that can be pushed upward repeatedly when the need arises?

Holger Schmieding, chief economist of Berenberg Bank in London, offers one reason for why it does. "It forces American politicians to reflect regularly on whether they really want to take on new debts," he told DW.

But American economist Irwin Collier, who heads the John F. Kennedy Institute for North American Studies at the Free University of Berlin, disagrees. "Congress already determines what the state should do, how much it should spend and how much it takes in," he told DW. "This additional limit has no real purpose."

A protester displays a placard as he joins others in a demonstration in front of the US Capitol in Washington (c) JEWEL SAMAD/AFP/Getty Images

This protester is encouraging the Republicans to stand firm on their debt opposition

Debt ceilings in Berlin and Brussels

Germany also instituted something like a debt ceiling in 2011, Economist Hans-Peter Burghof points out, with the country's most recent budget plansanticipating a surplus by 2015.

German politicians face even stricter controls when it comes to avoiding new debt than their American counterparts, Burghof said in an interview with DW. "We have created an even higher hurdle by making the abstention from new debts a constitutional matter."

At the European level, a similar budgetary instrument, the European Fiscal Compact, has been signed by 23 EU countries, 16 of which are members of the eurozone currency union.

Burghof points to another commonality on both sides of the Atlantic, saying that when Berlin, Brussels of Washington do not have any more money, cash has to be found somewhere.

"When it really gets down to the nitty gritty, you don't have any choice but to up the debt limit and make sure that the state remains solvent," he said.

A middle-aged man smiles at the camera Photo: Horst Galuschka

Economist Hans-Peter Burghof: Can you force a virtue?

Economic nightmare

If US politicians prove unable to reach an agreement on raising the debt ceiling, the consequences for both the American and the global economywould be wide-ranging. If the government runs out of money, it would have to slash its expenditures.

In Berlin, economist Irwin Collier believes it's impossible to predict how much money would be cut - or where and when. "There is no system," he said. "It will be pretty arbitrary which receipts end up getting paid."

A horrifying scenario would emerge should the US neglect or stop entirely its repayment of debts. Burghof says that's a risk no state can afford.

Berenberg Bank's Holger Schmieding takes a similar view, saying that if the US were to stop servicing its debts, people would "take it as a bad joke for a couple of days."

"But if it lasted any longer than that," he said, "the US would be regarded solely with distrust going forward and be punished with high interest rates."

A man with gray hair and eyeglasses looks off camera Copyright: imago/Becker&Bredel

Holger Schmieding says the debt ceiling makes politicians think twice

Forced to be virtuous?

Few seem to think the US would go so far as to lapse on its debts, and the credit rating agencies agree thus far, having left the US rating untouched. They haven't even subjected American bonds to scrutiny and seem far from acting to downgrade the country.

Irwin Collier is also confident the Democrats and Republicans will strike a compromise in Washington. "There will be some kind of six-month or three-month extension, and they'll meet with each other again."

Burghof agrees that the US will recognize it cannot afford the damage caused by a default. The debt ceiling debate touches on a philosophical question, the economist says: Can you compel someone to act virtuously?

As Burghof puts it, the US debt ceiling, the European Fiscal Compact and the most recent German budget all attempt "to take a politician's virtue of creating a responsible budget - even if it means losing votes - and replace it with a legal framework that has the same effect. We can see that, in the case of the US, it doesn't work," he said.

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