The US debt ceiling has been broken - will the mansion collapse?
The largest economy in the world could soon go bankrupt, resulting in “extraordinarily averse and longstanding harm” according to Fed Chair Jerome Powell. The US hit its debt limit - a hefty $31.381 trillion - on January 19 this year, leaving the Treasury to resort to ‘extraordinary measures’ to keep the economy from turmoil. Here’s what might happen if the limit isn’t raised before the so-feared ‘X date’.
Invented in 1917 to ensure the Treasury and the Government maintain fiscal possibility, the debt ceiling represents the maximum amount of money that the US can borrow by issuing bonds. However, the ‘house’ has been extended an incredible 78 times since 1962, to avert the catastrophic consequences of breaching this seemingly arbitrary measure. The last time the US came close to clashing with the ceiling was in 2011 when the Republicans managed to hold President Obama with his spending plans.
Why should it not be broken? “Failure to meet the government’s obligations would cause irreparable harm to the US economy, the livelihoods of all Americans, and global financial stability” according to the US Treasury Secretary Janet Yellen.
If exceeded, the government would be default on its debt - the Treasury won’t be able to borrow more and bond interest payments may be missed. This makes it more expensive to borrow - expectations of this battle has already sent yields upwards - as the credit rating is downgraded.
Also has worldwide repercussions (in markets), given how powerful and significant US economy is and can rock global financial stability. “An economic and financial catastrophe” as Yellen has proclaimed.
US Treasury securities (bonds), seen as safe assets behind the world’s largest economy, falling in value would cause a drop in the value of the US dollar, the currency of choice for 60% of the world’s reserves.
Past forecasts suggest a default could instantly bury the country in a deep recession, with EG already on a knife edge due to rising inflation. Moody’s Analytics made a report in the previous episode of this debt show in 2021 in which they predicted crashing markets, several million work layoffs and “the aftershocks of the crisis being felt for years to come”
The debt ceiling issue has stirred up political debate, increasing tensions between Democrats and Republicans and has repeatedly been used as a means of brinkmanship. After a first meeting with Biden, House Speaker Kevin McCarthy that they had a “very good conversation” and didn’t “want to put any fiscal problems to our economy”. Despite this, he was clear that the US “have got to change the way we are spending money wastefully in this country, comparing the government to giving a child a credit card and repeatedly hitting the limit”
Republicans, having secured control of the House, are planning to ask the Treasury to prioritise Social Security, Medicare, military funding and veterans benefits along with deep spending cuts, revoking some parts of the massive Inflation Reduction Act. This dubbed ‘prioritisation plan’ won’t work according to Yellen, deeming it to be a non-solution only lead to further chaos. On the other hand, Biden and the White House have taken a firm stance, expecting a “clean” no-strings-attached raise and saying they “won’t negotiate”. In a stern warning, their press secretary said it was Congress’ “constitutional responsibility” to raise the cap ‘without conditions’.
The question is whether any extraordinary measures - like creating a $1tn platinum coin to fund spending, halting contributions to pension and health care funds or even “shutdowns” with deferring government employee wage payments - outweighs the economic damage that could ensue from defaulting. The Fed might have to suspend its Quantitative Tightening, buying back bonds that the economy isn’t able to pay interest on, or artificially rise yield rates, although this creates a “premum” on debt - just ask Jeremy Hunt. If not, there would be have to be significant tax rises or public spending cuts, both damaging to the US economy.
Another issue at play here is whether it is really necessary if it just repeatedly going pushed back, like kicking a can down the road. Few countries have these, with those with a cap including Denmark and Poland. Speaking of other countries, China would be ‘cheering’ this battle on since it could be a way for their economic rival loses some of its economic leadership.
As the US Tax Day approaches this Sunday, the US economy continues to be behind its dues. Although they were expecting to max out in Q3 2023, there could be a possibility of a June ‘X-Date’, especially if there are lower-than-anticipated tax revenues. If they do, we can expect a “global economic meltdown”, cataclysmic to a global economy that is gradually finding its feet, still under the hot fire of inflation. Negotiations, concessions and deal-making are the need of the hour, to avoid US borrowing tipping over the edge into calamity.