There is a high probability that a deal will be signed before June 5 between democrat and republicans on debt ceiling as officials have indicated a tentative deal is in place. But let’s take a look at what is a ceiling on debt, who put it, what is it’s role and what if no deal is passed from Congress till the given deadline, what will be it’s economic implications for US economy and for rest of the world. The earliest possible date when US govt could run out of cash has been updated to June 5 by Fin secy Jenet Yellen.
What is debt ceiling?
Debt ceiling, a limit created by congress in 1917 is the maximum amount of outstanding federal debt the U.S. government can incur. It is to keep a watch on govt spending as deficit of US govt remains high. The US govt has run deficit averaging $1 trillion every year since 2001, meaning it spends that much more than it’s revenue from taxes and other sources. To overcome this shortfall govt has to borrow to finance the bills that congress has already authorized. Both national debt and ceiling stood at $31.4 trillion at the end of January 2023.
How often it is raised?
Debt ceiling is to have a mutual consent of both houses on govt spends and to keep deficit level under check, but raising the ceiling or abolishing it is a routine exercise. Whenever treasury department can no longer pay the government bills congress has acted swiftly to raise the limit on it’s borrowing. Ceiling have been raised 78 times since 1960, most recently in 2021. Congress can also choose to suspend the debt ceiling, or temporarily supersede the debt limit, rather than raise it by a specific amount. Congress has suspended the debt limit seven times since 2013.
Last occurrence of default or of a similar situation
In 2011, then President Barak Obama and republican led congress failed to come to a agreement resulting in protracted deadlock, Congress eventually reached a deal to raise the ceiling just two days before the date that the Treasury estimated it would run out of money. However, the dilemma following the event triggered the most volatile week for U.S. stocks since the 2008 financial crisis, and the credit rating agency S&P Global downgraded the United States’ creditworthiness for the first and only time ever.
The Government Accountability Office, which serves as the federal auditor, estimated that the delay in reaching a deal increased U.S. borrowing costs by $1.3 billion that year alone as rating downgrade by S&P global raised the borrowing cost for US government increasing already wider deficit gap.
Why so much fuss in agreement?
In last few years the debate is hot that whether this ceiling should be permanently abolished but often meet with disagreements from congressional budget hawks as they use it to demand spending cuts in return of their support. In recent years it is somewhat turned a bit into political negotiation as opposite parties try to raise their demands through it. This time President Biden and senior Republicans in the House of Representatives are negotiating an increase in exchange for reductions in federal spending.
Republicans are rigid on a demand that govt should lower it’s spends and drop the plan of raising taxes on ultra-rich. “If you gave your child a credit card and they kept hitting the limit, you wouldn’t just keep increasing it. You would sit down with them to identify where they are overspending and where they can change their behavior,” House Majority Leader Kevin McCarthy wrote on Twitter. “It’s time for the federal government to do the same thing.”
Good News, a tentative deal is in place, what next?
On Sunday, US President Joe Biden and house speaker Kevin McCarthy said they have reached a deal to lift the nation’s debt ceiling and confident that enough republican and democratic votes will be given to pass the negotiated deal in coming week. “The agreement prevents the worst possible crisis, a default, for the first time in our nation’s history,” Biden said. “Takes the threat of a catastrophic default off the table.”
Now the troubling part is disagreement of some lawmakers as resolution include spending cuts that may upset some, only time will tell whether a default is narrowly avoided or US economy slipping into a deep crisis. Both President Biden and house speaker McCarthy urged congress lawmakers to come forward and support the agreement.
What will happen if there is delay/ disagreement in deal?
Though highly unlikely but a delay or disagreement could bring catastrophic impact to US economy and for rest of the world. the reputation of the government for meeting its debt obligations would be in tatters and that reputation loss will cause US a lot of money. As US can borrow a lot of money(trillions) at very low rate due to it’s reputation of paying them back at time but a ‘default’ would make US a risky borrower bringing that very low interest rate to higher.
A no money scenario will mean government will not have money to give to it’s employees, to infra projects, government contracts, to social securities banishing millions of jobs around US. This all could shock stock market as borrowing and unemployment rates would jump, and a stock-market plunge could erase trillions of dollars in household wealth. It would all but shatter the $24 trillion market for Treasury debt. This could mean a repeat of 2008 financial crisis or even worse.
Read the white house view on how catastrophic a default would be.
What it could mean for rest of the world?
Experts say a US default could wreak havoc on global financial markets. The creditworthiness of US treasury securities has long bolstered demand for U.S. dollars, contributing to their value and status as the world’s reserve currency. Any hit to confidence in the U.S. economy, whether from default or the uncertainty surrounding it, could cause investors to sell U.S. treasury bonds and potentially weaken the dollar.
Over half of the world’s foreign currency reserves are held in U.S. dollars, so a sudden decrease in the currency’s value could ripple through the market for treasuries as the value of these reserves drops. As heavily indebted low-income countries struggle to make interest payments on their sovereign debts, a weaker dollar could make debts denominated in other currencies relatively more expensive and threaten to tip some emerging economies into debt or political crises.
Debt ceiling negotiation failure will mean a depletion in dollar value, making imports for US companies beneficial but that would not be significant as rise in borrowing cost will blanket that benefit. Emerging economies like China can also benefit from disagreement in debt ceiling as China is aspiring to establish its currency Chinese renminbi as a alternate currency for foreign reserve as depletion in dollar value and its overall reputation will force other countries to switch to some other currencies for time being but that won’t happen in my view.
Debt ceiling crisis if happens would significantly increase the price of precious metals gold and silver as demand for safe heaven all weather metal will pass the roof.
What is in the debt ceiling deal?
The debt ceiling deal revolves around cut in spending, republicans want gov to lower it’s spending for next few years to lower the fiscal deficit. Republicans are also in the view that govt should give up it’s populist schemes specially the one related to student loan waiver but democrats are opposing this. Both parties have to make compromises to come to a consensus.
McCarthy told reporters at the Capitol on Sunday that the agreement “doesn’t get everything everybody wanted,” but that was to be expected in a divided government. Privately, he told lawmakers on a conference call that Democrats “got nothing” they wanted.
Center of the compromise of this debt ceiling deal is two year budget that would essentially hold spending flat for 2024, while boosting it for defense and veterans, and capping increases at 1% for 2025. That’s alongside raising the debt limit for two years, this will put a hold on this debt ceiling controversy till 2025 way after next presidential election that is scheduled to happen in 2024.
Driving hard to impose tougher work requirements on government aid recipients, Republicans achieved some of what they wanted. What it means is people in ages 49 to 54 with food stamp aid would have to meet work requirements if they are able-bodied and without dependents. Biden was able to secure waivers for veterans and homeless people.
The deal puts in place changes in the landmark National Environmental Policy Act designating “a single lead agency” to develop environmental reviews, in hopes of streamlining the process. Debt ceiling deal plans to halt hiring of new Internal Revenue Service agents as Republicans demanded, and rescinds some $30 billion for coronavirus relief, keeping $5 billion for developing the next generation of COVID-19 vaccines.
Conclusion
Signing a debt ceiling deal will be a win-win situation for all but that not will be it. As debt ceiling talk was getting dragged Secretary Jennet Yellen warned that the treasury will only able to pay it’s bills till June 5. Treasury bills maturing before June 10-15 will be safe as market sees funds lasting till June 15 but beyond that bills will get bounce. A lot of bills are maturing in June and US may need to raise at least $1 trillion on urgent basis to pay them suggests Goldman Sachs in a detailed report.
As rate hike scenarios changing fast will update once there is concrete consensus.
