Common Fallacies Surrounding the 2023 Debt Ceiling Debates

Paul H. Kupiec1 and Alex J. Pollock2

May 7, 2023

Abstract

We investigate the veracity of current and former government officials’ claims made in the context of
the 2023 debt ceiling standoff: that it would be unconstitutional for the US to default on its debt; that
the US has never before defaulted; and there are no extraordinary measures that could be taken to
avoid a government default by mid-summer. We show that all of these claims are demonstrably untrue.

1. The Debt Ceiling and a Federal Government Default

The news media are full of stories and opinion pieces about the debt ceiling, many of them repeating
administration officials’ and their surrogate’s claims designed to promote a particular narrative. Stories
claim that:

I. It is unconstitutional for the U.S. to default on its debt;

II. The U.S. has never defaulted on its debt;

III. There are no extraordinary measures that can be taken to prevent default, so the only solution
to averting a looming debt crisis is to raise the debt ceiling.

In the discussion that follows, we analyze these claims and explain why they are exaggerations if not
demonstrably untrue.

2. The Constitutionality of a Federal Government Default

The 14th Amendment to the Constitution, ratified in 1868, included language that asserted the validity of
war debt incurred by Union while forbidding repayment of any debts incurred by the states of the
Confederacy. The amendment states in part:

“The validity of the public debt of the United States, authorized by law, including debts incurred
for payment of pensions and bounties for services in suppressing insurrection or rebellion, shall
not be questioned.”

And further:

“Neither the United States nor any state shall assume or pay any debt or obligation incurred in
aid of insurrection or rebellion against the United States…but all such debts, obligations and claims shall
be held illegal and void.”

The Civil War context is clear.

1
Senior Fellow, American Economic Institute.
2
Senior Fellow, Mises Institute.

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Legal scholars and politicians have debated whether this amendment makes it unconstitutional for the
federal government to default on its debt. In the midst of the 1995-1996 debt ceiling negotiations, then
president Bill Clinton said, if need be, he would use the 14th Amendment as justification for ignoring the
debt ceiling “without hesitation, and force the courts to stop me.”

In contrast to the Clinton administration, the Obama administration was reluctant to use the 14th
amendment as justification for ignoring the Congressional debt ceiling. During the 2011 debt ceiling
negotiations, George Madison, then Treasury general counsel wrote that Treasury Secretary Tim
Geithner “has never argued that the 14th Amendment to the U.S. Constitution allows the President to
disregard the statutory debt limit… the Constitution explicitly places the borrowing authority with
Congress, not the President.” When the debt ceiling debate was revisited again in 2013, president
Obama’s press secretary Jay Carney told reporters, “This administration does not believe that the 14th
Amendment gives the power to ignore the debt ceiling.”

There is a wide range of opinions about the implications of the 14th amendment for a government
default. Some argue that the 14th amendment makes Congressional debt ceilings unconstitutional, in
spite of the fact that they have existed and been enforced for more than a hundred years. Some make a
distinction between a temporary delay of payments and a debt repudiation. In our view, the 14th
Amendment argument, besides being open to various opinions, is weak when we consider that the
United States has in fact defaulted on its debt multiple times since its adoption. One of these default
events was explicitly upheld by the Supreme Court.

3. US History of Federal Government Defaults

Arguments that a default on government debt has never happened are belied by the fact that the U.S.
government has defaulted on its debt three times since the ratification of the 14th amendment, in 1933,
1968, and 1971, in addition to twice before the Amendment, in 1814 during the War of 1812, and in
1862, during the Civil War. In 1979, the government experienced a mini-default event when the US
Treasury was for a brief period operationally unable to make timely payments to retail investors in
Treasury securities.

In chronological order these are: The 1814 inability to honor specie payments due on government loans
taken out to finance the War of 1812; the 1862 inability to redeem greenbacks for the promised gold or
silver. The 1933 refusal to redeem Treasury gold bonds for gold, as had been unambiguously promised
by the U.S. government. The 1968 refusal of the U.S. government to redeem silver certificates for silver,
in spite of the unambiguous promise on each certificate that “There has been deposited in the Treasury
of the United States of America one silver dollar, payable to the bearer on demand.” The 1971 refusal
(since the Treasury would soon have been faced with the inability as it ran out of gold) to redeem the
dollar claims of foreign governments for gold, as promised in the Bretton Woods Agreement, approved
by the Congress in 1945. Finally, in late April and early May 1979, about 4,000 Treasury checks for an
estimated $122 million in interest and security redemption payments were delayed by problems related
to the reorganization of the Treasury’s debt operations. Regular payment schedules resumed by mid-
May.

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The 1933 gold bond default is a particularly instructive case, since the government’s refusal to make
gold payments it had promised was upheld by the Supreme Court in a 5-4 decision in 1935.3 Wrote the
majority opinion of the Court:

“The question before the Court is one of power.”

“Contracts, however express, cannot fetter the constitutional authority of the Congress”—that is,
the authority not to pay in the explicitly promised gold.

The four-member minority was pretty clear in its view:

“The enactments here challenged will bring about the confiscation of property rights and the
repudiation of national obligations.”

A concurring opinion summed it up nicely:

“While the government’s refusal to make the stipulated payment is a measure taken in exercise of
[its] power, this does not disguise that fact that its action is to that extent a repudiation.”

“As much as I deplore this refusal to fulfill the solemn promise of bonds of the United States, I
cannot escape the conclusion announced for the Court.”

Among the US government defaults, the U.S. government in 1971 reneging on its Bretton Woods
commitments was the most important since it fundamentally changed the global monetary system. This
default put the whole world on a pure fiat currency system which has so far lasted more than 50 years.

History makes it abundantly clear that any sovereign government, including the U.S. government, can
default on its promised debt payments. There have been more than 200 sovereign defaults over the last
two centuries, continuing up to the present day, and the U.S. is not an exception to this world-wide
record.

4. Is an Increased Debt Ceiling the Only Way to Delay an Impending Default?

Contrary to assertions by the Secretary of the Treasury and the Chairman of the Federal Reserve, there
are several emergency measures that could be used to postpone the day the U.S. Treasury runs out of
cash without Congressional authorization to increase the debt limit. Invariably, these measures involve
the Federal Reserve. In the remainder of this essay we will detail legal measures other than raising the
debt ceiling that could be taken to avoid default. These measures leave open alternative sources of
funding that could be utilized to allow the federal government to continue paying its bills.

4.1 Recognizing the Market Value of the Treasury’s Gold

The Treasury owns 261.5 million ounces or 8,000 tons of gold that has a current market value of almost
$578 billion at the market price of about $2,000 per ounce. The value of the Treasury’s gold for
government accounting purposes is set by the Par Value Modification Act of 1973. This act amends the
Gold Reserve Act and “directs the Secretary of the Treasury to take steps necessary to establish a new
par value of the dollar… of forty-two and two-ninths dollars per fine troy ounce of gold. “

3
Perry v. United States, 294 U.S. 330 (1935).

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Today we face the potential of a federal government default because of a law passed in 1973 that
requires the US Treasury to value its gold at $42.22 on ounce—an absurd price 50 years out of date.
Based on this legislated price, under powers granted in the Gold Reserve Act, the US Treasury has
already issued $11 billion of gold certificates against its gold holdings. These certificates were deposited
with the Federal Reserve and monetized into $11 billion in spendable balances that were spent long ago.

If Congress were simply to amend Par Value Modification Act by striking “42 and two-ninths dollars”, the
legal price of gold set in 1973, and replace it with “the current market value (as determined by the
Secretary at the time of issuance),” the Treasury could create and monetize more than $500 billion in
new gold certificates with no additional debt issuance.

This gold certificate “extraordinary measure” is not just a hypothetical idea. In 1953, when the
Eisenhower Administration faced a debt ceiling standoff, it issued $500 million in new gold certificates
to avoid a government default. The transaction worked as intended.4 The Treasury issued gold
certificates and used them to repurchase $500 million in Treasury securities held by the Federal Reserve.
The Treasury immediately canceled the securities formerly held by the Fed and sold $500 million in new
debt securities to replenish its coffers without an increase in the debt ceiling. Today, a similar
transaction could be used to create more than $500 billion in new debt issuance capacity for the US
Treasury.5

4.2 Prioritizing Treasury Claims using the Federal Reserve’s Balance Sheet
The Federal Reserve district banks collectively own $5.3 trillion in US Treasury securities. These
securities count against the debt ceiling even though on a consolidated government basis they are
“effectively owned” by the US government. We say “effectively owned” because the stock of the
Federal Reserve Banks is owned by its member commercial banks. However, because of the way the
Federal Reserve is currently operating, any profits or losses on the Fed’s US Treasury securities portfolio
are born by US taxpayers and not by Federal Reserve member bank stockholders. As we explain below,
this fact, federal budget accounting rules, and the unique way the Congress has allowed the Fed to
account for its operating losses creates the possibility of using the Fed to raise a substantial amount of
Treasury cash to avoid a government default without raising the Congressional debt limit.

Consider what would happen if the Treasury avoided default by prioritizing payments so that it did not
make any payments on the Treasury securities held by the Federal Reserve. We believe the Federal
Reserve could “voluntarily” prioritize Treasury payments by forgiving the US Treasury’s obligation to
make interest and principal payments on a portion of the US Treasury securities it owns. This

4
As reported in the 1953 Annual Report of the Board of Governors of the Federal Reserve System, p. 5.
5
In 1977, the Fed was also employed to help the Treasury avoid default in the face of a binding debt ceiling
constraint. The Treasury directly placed short term paper with the Fed to raise cash to avoid default. On
September 30, 1977, a temporary Congressional debt ceiling authorization for $700 billion expired before
Congress passed a new debt ceiling authorization thereby reverting the authorized debt limit to $400 billion.
The Treasury requested, and the Federal Open Market Committee approved an increase “from $2 billion to $3
billion the limit, specified in paragraph 2 of the authorization for domestic open market operations, on
Federal Reserve holdings of special short-term certificates of indebtedness purchased directly from the
Treasury.” Amendments to the Federal Reserve Act passed in 1979 now preclude the Fed from making direct
Treasury purchases, but issuing gold certificates is still authorized by law.

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extraordinary measure could provide the US Treasury with funds needed to forestall a government
default without any increase in the Congressional debt ceiling.

As we explain below, be believe that, given the enforcement of current law, federal budget rules, and
Federal Reserve practices, such an extraordinary measure is not only permissible, but can be used to
circumvent the Congressional debt ceiling and free up potentially a trillion or more dollars in new deficit
financing capacity for the US Treasury without creating any operating difficulties for the Federal
Reserve.

4.2.1 The Fed Voluntarily Forgives Treasury Debt Payments

Voluntary US Treasury debt forbearance or even forgiveness by the Federal Reserve on securities it
owns would not constitute a federal debt default. It would impact payment transfers within the Federal
Government, but the way he Fed currently operates, no external non-federal governmental party would
experience a delay or default on federal payment obligations. Consequently, arguments related to the
fourteenth amendment would not be applicable.

Does the Federal Reserve Act preclude Treasury debt forbearance or forgiveness? Perhaps on some
securities, but certainly not on most of the $5.5 trillion of US Treasury securities owned by the Fed.
Section 1101 of the Dodd-Frank Act amended the Federal Reserve Act to require the Federal Reserve
Board to “establish…policies and procedures… designed to ensure that any emergency lending program
or facility …protect taxpayers from losses…” However, the vast majority of the Fed’s US Treasury
securities were not acquired as part of an “emergency lending program or facility” and so would be
exempt from this provision. If member banks were harmed by Fed forgiveness, as the owners of Federal
Reserve district bank shares, they might have legal standing to stop such a giveaway. But as we explain
below, under current Federal Reserve operating policies, member banks would not be harmed if the Fed
took this extraordinary measure.

4.2.2 Fed Operating Policies Accommodate Treasury Debt Forgiveness

When Federal Reserve district banks suffer losses, the Federal Reserve Act prescribes that member
banks share in their district bank losses. Moreover, member banks could be called on to recapitalize
their Federal Reserve district bank. Notwithstanding these provisions in the Federal Reserve Act and
ongoing Federal Reserve district bank operating losses, member banks are still being paid dividends and
interest on their reserve balances and have not been required to share in district bank losses or required
to purchase additional shares to recapitalize technically insolvent Federal Reserve district banks.

The Federal Reserve Act requires member banks to subscribe to the shares issued by their Federal
Reserve district bank in a dollar value equal to 6 percent of a member institution’s paid in capital and
surplus. Subscribed share amounts must be updated annually, but member banks need only pay the Fed
for half the subscribed balance. The Federal Reserve Act stipulates that the “remaining half of the
subscription shall be subject to call by the Board.”

Presumably the founders believed that such a request might be forthcoming if a Federal Reserve Bank
suffered large losses which eroded its capital. In addition, Section 2 of the Act [12 USC 502] requires
member banks be assessed for district bank annual losses up to twice the par value of their Federal
Reserve district bank stock subscription.

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 “The shareholders of every Federal reserve bank shall be held individually
responsible, equally and ratably, and not one for another, for all contracts,
debts, and engagements of such bank to the extent of the amount
subscriptions to such stock at the par value thereof in addition to the amount
subscribed, whether such subscriptions have been paid up in whole or in part under the
provisions of this Act.” (bold italics added)

To the best of our knowledge, this provision of the Federal Reserve Act has never been exercised and it
is certainly not being exercised today.

In return for their share capital and contingent loss liability, member banks were initially entitled to
receive a 6 percent cumulative dividend on the par value of their paid-in shares. Subsequently, Congress
reduced the dividend rate paid to large banks to the lesser of “the high yield of the 10-year Treasury
note auctioned at the last auction (currently 3.46%) held prior to the payment of such dividend, or 6
percent.” The Fed is now posting large operating losses but is still paying member banks all their
dividends.

Unlike normal shareholders, member banks are not entitled to receive any of their Federal Reserve
district bank’s profits beyond their statutory dividend payment. The legal requirements and Federal
Reserve Board policies governing the distribution of any Federal Reserve System earnings in excess of its
dividend and operating costs have changed many times since 1913, but today, as a practical matter, the
Fed is required by law to remit basically all positive operating earnings after dividends to the US
Treasury—but there are now no earnings to remit.

Beginning in mid- September 2022, the Federal Reserve started posting operating losses. Through May
3, 2023, the Fed has accumulated nearly $54.5 billion in operating losses. In the first 4 months of 2023,
the Fed’s monthly cash losses averaged $8.5 billion. These monthly losses will increase as a consequence
of the FOMC’s May 4 decision to increase its Federal funds rate target by 25 basis points, which
increases the interest rate the Fed must pay on bank reserves and reverse repurchase agreements.
Notwithstanding these huge losses, the Fed continues to operate as though it has positive operating
earnings with two important differences—it borrows to cover its operating costs, and it has stopped
making any remittances to the US Treasury.

The Fed funds its operating loss cash shortfall by printing paper Federal Reserve Notes, or by borrowing
reserves from banks and other financial institutions through its deposits and reverse repurchase
program. The Fed’s ability to print paper currency to cover its losses is limited by the public’s demand
for Federal Reserve Notes. The Fed borrows most of the funds it needs by paying an interest rate 5.15
percent on borrowed deposit balances and 5.05 percent on the balances borrowed using reverse
repurchase agreements.

In spite of its losses, the Fed continues to pay member banks both dividends on their shares and interest
on their reserve deposits. The Fed has not exercised its power to call the second half of member banks’
stock subscriptions nor has it required member banks to share in the Fed’s operating losses. Instead of
assessing member banks to raise new capital to cover its losses, the Fed uses nonstandard, “creative”
accounting to obscure the fact that its accumulating operating losses have rendered it technically
insolvent.

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Under current Fed accounting policies, its operating losses accumulate in a so-called “deferred asset”
account on its balance sheet. These balances are actually negative retained earnings, a reduction in Fed
capital. The Fed books its cumulative operating losses to date as an intangible “asset.” This treatment
of Federal Reserve System losses is clearly inconsistent with generally accepted accounting standards,
and seemingly inconsistent with the Federal Reserve Act’s treatment of Federal Reserve losses, but
Congress has done nothing to stop the Fed from utilizing these accounting hijinks.

Under these Fed operating policies, if the Treasury securities owned by the Fed were forgiven and
written off, the Fed would immediately recognize an additional operating loss equal to the value of the
forgiven Treasury securities, say for example, $1 trillion. The Fed would then incur additional interest
expenses, increasing ongoing operating losses, as it would no longer receive interest payments from the
Treasury on these securities. It would increase its borrowings of bank reserves and reverse repurchase
agreement loans to replace the interest income on the forgiven Treasury securities. All the losses would
be added to the Fed’s “deferred asset” account. By virtue of the federal budgetary accounting rules, the
Fed’s deferred asset account balances and its operating losses do not count as expenditures in federal
budget deficit calculations, nor do the Fed’s borrowings to fund its operations count against the
statutory debt ceiling.

Federal Reserve forgiveness of Treasury debt would not actually reduce the total debt of the
consolidated government because the Fed borrowings (in the form of bank reserves and reverse
repurchase agreement loans) to buy the forgiven Treasury securities would remain a liability of the
Federal Reserve System. Should the Fed forgive, for example, $1 trillion of the Treasury securities it
owns, the Fed’s balance sheet would include $1 trillion more liabilities than tangible assets. These Fed
liabilities are without doubt debt of the consolidated federal government, but Fed liabilities are
uncounted on the Treasury’s books or in Congressional debt ceiling calculations, so the accounting
would look like the forgiven US Treasury securities disappeared.6

4.2.3 Limits to Federal Reserve Debt Forgiveness

The Federal Reserve owns $8.1 trillion in the combination of US Treasury securities, federal agency-
guaranteed mortgage backed securities (MBS), and US federal agency debt. US Treasury securities
account for $5.5 trillion of the Fed’s $8.1 trillion securities portfolio.

The Fed uses some of its securities holdings to collateralize the Federal Reserve Notes (paper dollars) it
issues and the amount it borrows in capital markets using reverse repurchase agreements. The Fed must
collateralize the $2.3 trillion in Federal Reserve Notes it has issued to the public. These can be
collateralized with any of the securities it owns it its $8.1 trillion portfolio. The Fed has borrowed $2.8
trillion using reverse repurchase agreements. Again, these repos could be collateralized using any of the
securities in the Fed’s portfolio.

6
The accounting transactions could be accomplished as follows. The Fed could increase its deferred asset account
buy $1 trillion and at the same time credit the Treasury’s cash account by $1 trillion. The Treasury could then use
this new $1 trillion in cash to directly purchase, at the Fed’s amortized cost basis, $1 trillion in US Treasury
securities owned by the Fed. The Treasury would cancel these repurchased securities freeing up roughly $1 trillion
in capacity to issue new US Treasury debt securities to the public and the Fed would have $1 trillion in additional
balances in its deferred asset account.

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Say for example, the Fed uses $2.3 trillion of its $2.6 trillion in agency and MBS securities it owns to
collateralize publically circulating Federal Reserve Notes, and $2.8 trillion of its $5.5 trillion US Treasury
securities to collateralize its reverse repurchase agreement borrowing. That would leave the Fed with
$2.7 trillion in unencumbered US Treasury securities that potentially could be forgiven. The Fed would
want to retain a buffer of Treasury securities available for use in its ongoing monetary policy operations.
Taking this into account, conservatively, the Fed could “afford” to forgive up to $1 trillion of its US
Treasury securities without any material impact on its ability to conduct monetary policy.

Forgiving $1 trillion in US Treasury securities, while feasible, would increase uncounted Federal
government debt and delay for decades the time that would elapse before the Fed resumed making
remittances to the US Treasury. To be clear, we are not recommending that this extraordinary action
be taken. To the contrary, we point out this giant loophole in the control of federal government finances
in the hope that Congress will take up this issue and reform Federal Reserve and federal budget
accounting policies to foreclose the possibility of using such an approach for circumventing the
Congressional debt limit.

5. Conclusion
In contrast to claims that have often been made in the context of the current debt ceiling debate, a
default on the federal government’s debt does not appear to be unconstitutional despite arguments
that appeal to the 14th amendment. Since the passage if the 14th amendment, the US government has
defaulted on its debt three times and delayed promised US Treasury security payments on a fourth
occasion. The US supreme court adjudicated and rejected a claim that the 1933 Congressional
repudiation of the government’s obligation to honor gold redemptions was unconstitutional. Moreover,
we discuss concreate extraordinary measures that could be legally taken to create a substantial amount
of new cash balances the US Treasury could use to forestall a government default without raising the
Congressional debt limit. One of these extraordinary measures was utilized in the past to avoid default
and remains a legal option today. An alternative extraordinary measure utilizing Federal Reserve debt
forgiveness has yet to be attempted but appears to be possible under current Federal Reserve and
federal budget accounting policies.

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