Tag: debt limit

The story so far: United States Treasury Secretary Janet Yellen notified Congress last week that the country could default on its debt as early as June 1, if the Republican-dominated House of Representatives and President Joe Biden’s White House did not reach a consensus to raise or suspend the debt ceiling. A default on its debt, something that has never happened before, could send shockwaves in global financial markets, increase borrowing costs for the U.S. and impact the dollar’s reputation as a reserve currency.

What is the U.S. debt ceiling?

When the federal government spends more than it brings in, in terms of taxes and other revenue, it runs up a budget deficit. Since 2001, this deficit has averaged $1 trillion annually. It then has to borrow money to meet its financial obligations, accruing debt. The government borrows tby creating and selling debt securities like bonds to U.S. investors and companies, banks, pension funds, foreign investors and countries. The largest part of these are owned by the U.S. federal government itself, which keeps the money for social security schemes, medicare, federal pensions and so on.

While the administration and Congress decide on taxation and spending, the collection of taxes and the borrowing of funds is done by U.S. Treasury Department. In 1917, Congress passed the Second Liberty Bond Act, to allow then-President Woodrow Wilson to take out funds for the First World War without waiting for the approvals of absent Congress lawmakers. However, curtailing the President’s spending capacity,the Congress created a limit on borrowing ($11.5 billion at the time), thus creating a debt ceiling that could only be raised by approval of the Congress (House and Senate).

The debt ceiling started to take its present-day form in 1939, when separate borrowing caps for bonds were consolidated into one debt ceiling, then set at $45 billion. The U.S. government has hit or come close to hitting the debt ceiling multiple times.According to Treasury Department figures, Congress has acted 78 separate times since 1960 either to permanently raise, temporarily extend, or revise the definition of the debt limit – 49 times under Republican presidents and 29 times under Democratic Presidents. The last such change was in 2021.

While the government continues to receive taxation revenue after hitting the debt ceiling, it cannot borrow any more to pay its existing bills. The U.S. hit its current debt limit of $31.4 trillion on January 19 this year, but the Treasury activated the “extraordinary measures” mechanism to allow the government to meetits obligations. These extraordinary measures are accounting adjustments within several government accounts that temporarily reduce the amount of U.S. Treasury securities issued to them. These actions include suspending new investments or redeeming existing investments early.

However, if the debt ceiling is not raised once the government exhausts extraordinary measures and runs out of cash, the U.S. would be unable to pay its debt-holders, resulting in a default.

Why have debt ceiling standoffs become a recurring issue?

For starters, the debt ceiling is not a “forward-looking” budgeting instrument, i.e. it does not reveal what potentially ideal levels of spending look like. First, Congress approves programmes for which it does not have the entire funding, and then there’s a limit on how much the Treasury can borrow to pay for these already approved programmes. Which is why economists have called it a “strange” instrument. Take this analogy, for instance: first Congress approves $100 of spending, $70 comes in from taxes but the cap on what the government can borrow to pay for the rest is fixed at a mere $15.

Only one other country apart from the U.S. has a set ceiling on borrowing— Denmark. However, Denmark’s debt ceiling is set several times higher than the country spends; in 2021, the debt of Denmark’s central government was just 14% of its ceiling, notes the Council on Foreign Relations (CFR).

Another reason why disagreements overthe debt limit happen often, almost annually since 2011, is that it has become a political bargaining chip, as any raise or suspension has to be approved by Congress. As American politics becomes increasingly polarised, the Opposition has often used the debt limit as a way of getting budgetary and other legislative concessions. Sometimes, debt rate hikes have also been tied to the passing of certain bipartisan legislations. Reuters points out that Congress has often imposed conditions on these debt-ceiling hikes, or paired them with other tax and spending activity.

In 1957, Congress delayed a debt-ceiling hike to pressure the Pentagon to operate more efficiently, and in the early 70s, linked increases to expanded Social Security benefits. In 2018 and 2019, debt-ceiling was tied with broader bipartisan spending packages. However, debt ceiling decisions have not always been smooth, with the U.S. coming dangerously close to defaulting on its debt in 2011 when the Republicans and the Barack Obama administration could not reach an agreement t till the last minute. This was the first and the last time that rating firm S&P downgraded America’s prized ‘AAA’ credit ratings. The political gridlock led to a government shutdown, sent financial markets reeling, and caused a huge stock sell-off.

Observers have called the current impasse between House Republicans and the Biden administration even messier than in 2011. The Republican Speaker Kevin McCarthy-led House passed a Bill that pairs a $4.8 trillion in spending cuts with an increase in the debt ceiling of $31.4 trillion. However, Mr. Biden said that he wants a clean debt-ceiling height and won’t negotiate any kind of spending cuts, resulting in the current deadlock.

Treasury Secretary Ms. Yellen and other economists suggest doing away with the debt ceiling, which once served a purpose but does not contribute to fiscal discipline anymore and leads to frequent political grandstanding, often at the risk of national and global financial stability.

What will happen if the U.S. defaults?

Analysts say there is no set post-default scenario since the U.S. has never actually defaulted on its debt before. They have warned, however, of a “catastrophic” situation for American and global financial markets. The New York Times notes that after the extraordinary measures get exhausted and cash with the treasury runs out, the government would be unable to pay its bills including military salaries, benefits to retirees, and interest and other payments it owes to bondholders. If the government cannot make interest payments to domestic and foreign investors who own its debt securities, it could plunge the globe into a financial crisis, say Wall Street experts.

The CFR points out that the “unthinkable” event of a U.S. default could lead to another downgrade of U.S. creditworthiness by agencies, large-scale job losses, weakening of the dollar, stock sell-offs, and a rise in the cost of borrowing for the U.S. government. It would also increase the national debt, in turn causing widespread interest rate hikes for business owners, mortgages, and other sectors. A drop in U.S. consumer confidence would translate to shocks in the financial market, tipping the economy into recession.

The creditworthiness or the confidence in the repayment ability of U.S. treasury securities has long strengthened demand for U.S. dollars and made it the world’s reserve currency, with more than half of the world’s foreign currency reserves held in U.S. dollars. A loss of confidence in the U.S. economy, resulting from default or even the uncertainty around it, could force investors to sell U.S. Treasury bonds, thus weakening the dollar. A sudden decrease in the currency’s value could domino across treasury markets as the value of these reserves drops.

What are the Republicans demanding in their package in exchange for a debt ceiling hike?

The legislation passed by the Republican-led U.S. House of Representatives would suspend the U.S. debt limit till March 31, 2024, or until it increases by another $1.5 trillion, whichever comes first. The Bill would cut a wide range of government spending back to last year’s levels, amounting to a decrease of $4.8 trillion or about 9%. As per the nonpartisan Congressional Budget Office, the plan could save roughly $3.2 trillion over the coming years and reduce the U.S. government’s borrowing costs by $547 billion over a period of 10 years. However, Mr. Biden is not willing to negotiate spending cuts affecting his plans to cancel student debt, or those reducing healthcare for the poor, tax revenue, or green initiatives, among other things.

While it is not certain how this would impact government operations, the Department of Transportation said that it would shut down 375 air-traffic control towers (affecting jobs) and the Department of Agriculture indicated that it could make it tougher for almost a million Americans to access federal food aid.

The legislation plans to cancel healthcare, infrastructure, rental aid and other funds remaining unspent from the $5.2 trillion approved by Congress in the last three years for COVID-19 relief. It would reverse President Biden’s effort to cancel up to $10,000 of student debt for some borrowers and hamper another plan to peg debt repayment to borrower income levels. It also aims to reverse legislation increasing the budget for the Internal Revenue Service, which was to be used for hiring more employees and technological advancements to augment tax revenue.

The Republican Bill would also tighten work requirements for participants in some government poverty alleviation programmes. For example, adults up to age 56 not having children receive health insurance through the Medicaid program covering low-income individuals. They would have to work at least 80 hours a month to take part in job training or community service.

While Mr. Biden has not met with Republican leaders including Mr. McCarthy since February, with the Treasury Secretary’s June 1 warning, the White House has called a meeting with top Congress leaders of both parties on May 9, to discuss the debt-ceiling issue.

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