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5 Things You Need to Know About the Debt Ceiling

It's about time.

As Fortune noted in April, chances were good that the debt ceiling would become a hotter topic than the weather this summer.

Finally, it's looking likely that following talks between House Speaker Nancy Pelosi and Treasury Secretary Steven Mnuchin, the parties are close to reaching a deal to extend the debt ceiling through July 2021, permanently end the sequester that can automatically cut spending, raise the combination of both domestic and military spending by $320 billion a year, and include $75 million in spending offsets to bring down net deficit spending so there's just a little less annual contribution to the national debt.

Here's what you need to know to follow the developments.

What is the debt ceiling?

The debt ceiling is a tool government uses to control the amount of debt the country has. The U.S. has dealt with fluctuating debt since its inception. In the far past, Congress had to authorize borrowing by the Treasury for every need.

In 1917—when the country was spending heavily on World War I—Congress passed a law to change debt management. The Treasury received blanket permission to undertake certain types of debt, like bonds, so long as the total stayed within set bounds. Congress expanded the concept in 1939 to cover all total U.S. debt.

Congress has had to repeatedly increase the debt ceiling many times since then to accommodate the amount of borrowing the U.S. has undertaken.

Why does the debt ceiling keep going up?

There are two reasons. One is that the country keeps spending more than it takes in. The 2017 tax bill exacerbated the problem far beyond what its proponents projected, with the amount added this fiscal year (through October 2019) potentially adding another $1.4 trillion.

The other reason is interest payments on previous debt. The U.S. periodically rolls over existing debt to keep most of the owed money outstanding. As interest rates rise, or debt grows, the country pays more total interest. As the budget watchdog Peter G. Peterson Foundation notes, interest on the debt will become the third-largest single "program" in the budget by 2025, according to Congressional Budget Office estimates.

Why don't we end borrowing to reduce spending?

The debt doesn't cover future spending but, instead, previous spending and financial obligations, including interest payments on the national debt.

You can think of the national debt like a credit card account. The country plans spending and then the bills come due, including the interest. There isn't enough money coming in to cover what is due, so the government borrows. Unlike a credit card, the borrowing also occurs to cover previous credit card bills, so the amount keeps adding up.

What would happen without a debt ceiling increase?

Economists largely agree that this would be a disaster, although no one can predict exactly what would happen. One metaphor a former government staffer told Fortune is that it would be like asking what would happen if all the atomic weapons in the world went off at once. Would it be a tragedy beyond comprehension or, instead, would it wipe out all life?

Some of the possible outcomes would be a run on the dollar, the end of the dollar as the world's reserve currency, global market crashes, interest rates on federal debt would raise (along with the impact on the budget), and potentially payments to government workers and contractors as well as Social Security and Medicare and Medicaid recipients could end. Let's just say it would be really, really bad.

So, the debt ceiling will be fixed. Right?

Hopefully. This isn't a fight most people in Congress want, especially as it isn't clear that it would benefit any of them politically. Reports quote President Trump as saying that the White House was having "very good talks" with congressional leaders. But he's suddenly changed his mind before on agreements.

Additionally, some of the more conservative members of Congress have said they are unhappy with the level of spending cuts and that the current deal is not fiscally responsible. Might they try to block an agreement until they get what they want? Maybe.

Time is running out. There needs to be some kind of budget deal by September 30 to keep the government open. Additionally the Treasury officially runs out of options beyond a partial default earlier in September, and Congress is quickly coming up on its August recess.

It's may always be a hot topic, but hopefully cooler heads will prevail.

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