A peculiar law in America’s fiscal structure indicates that the world’s largest economy is on the verge of running out of cash. The US Congress has been debating whether to raise or suspend the so-called “debt ceiling,” which controls how much money the US government may borrow.
Treasury Secretary Janet Yellen has warned that if the ongoing stalemate between Republicans and Democrats is not broken, the administration may be unable to pay its bills as soon as June 1.
Meanwhile, Fitch Ratings has threatened the US economy with a reduction of its AAA rating, claiming that ‘risks have risen’ that the debt ceiling will not be raised.
“We believe risks have increased that the debt limit will not be raised or suspended before the x-date [when the government expects to run out of money], and as a result, the government may begin to miss payments on some of its obligations,” Fitch said.
The increasing political stalemate and the approaching prospect of the United States defaulting on its debt have caused some Democrats to call on Joe Biden to sidestep Republicans and avoid a default by invoking the 14th Amendment. However, legal experts think that would be risky.
However, the consequences of a default would be worldwide and disastrous. “That’s when you’re dealing with a genuine potential financial market catastrophe,” says Andrew Hunter, Capital Economics’ deputy chief US economist.
What’s going wrong, and how bad may things get?
What is the debt ceiling in the United States?
Since 1917, the United States has had a legislation that establishes a statutory limit on the total amount of debt that the government may incur. The initial cap was set at $11.5 billion (£9.2 billion).
The ceiling is analogous to the fiscal rules imposed by the Chancellor in the UK, except it is set outside. “The main issue is that it is treated completely apart from decisions about how much the government should spend and what level of taxes should be,” Hunter adds.
The debt ceiling is not lifted until the debt is ready to be violated. The sum was also set as a blanket cash figure that does not vary automatically to reflect factors such as population growth or inflation, thereby acting as a gastric band.
Every president since Herbert Hoover has raised the federal government’s debt. The debt ceiling has been increased more than 100 times in response. It is presently worth $31.4 trillion.
The US national debt reached this threshold in January, which implies the government can no longer legally borrow money.
Why hasn’t the debt limit been raised?
The debt ceiling can be raised again, but only with the approval of the Republican-controlled House of Representatives. When the ruling party lacks a majority in the House, as the current administration does, there is no certainty that an agreement will be realised.
Republicans are attempting to use the deadline to put President Joe Biden under pressure to agree to spending cuts. On April 26, the House adopted a bill to expand the debt limit by $1.5 trillion, but only if expenditure was reduced to 2022 levels and thereafter capped at 1% growth each year.
There is a political impasse, which implies that the future of the American economy is in limbo. If an agreement is not achieved fast, the consequences could be dramatic.
The president is urging lawmakers to remove the federal government’s self-imposed borrowing ceiling. Meanwhile, Republican House Speaker Kevin McCarthy has stated that his chamber will not adopt any deal that does not include spending cuts to address the nation’s mounting fiscal imbalance.
Historically, debt ceiling battles have ended with a hastily struck compromise in the last hours of discussions, avoiding a default. The scramble resulted in a downgrading of the country’s top-tier credit rating in 2011. Veterans of that conflict warn that the current scenario is far more dangerous since political schisms have become wider.
What if the debt ceiling cannot be increased?
The United States government operates at a deficit, which implies that it spends more money than it earns in taxes.
This implies two things. For starters, the magnitude of the debt grows each year, as do the costs of servicing it. Second, if the government is unable to borrow any more money, it will no longer be able to cover all of its expenses.
The US Treasury’s cash balance was $316 billion at the end of April. “The question is, when will that cash run out?” Hunter asks. Treasury Secretary Janet Yellen has stated that it will happen in June.
When this money runs out, the government will be able to spend only the money it receives in taxes. As a result, it will no longer be able to meet all of its public spending responsibilities, such as paying public sector salaries, nor will it be able to repay all of its existing debt.
Treasury debts maturing in June may not be repaid. According to Hunter, this might precipitate a financial disaster.
When does the situation have to be resolved?
The deadline is drawing closer and closer. When Yellen warned House Speaker Kevin McCarthy in January that the debt ceiling will be reached shortly, she indicated it was improbable that the funding would run out before early June.
However, at the beginning of May, Yellen stated that the date might be as soon as June 1. She said that the actual date “could be a number of weeks later than these estimates” at this time.
According to The New York Times, if the government can continue until mid-June, when its quarterly tax receipts arrive, it will have some short-term breathing room.
Yellen, on the other hand, has now doubled down on her June 1 warning. She emphasised in a fresh letter to House Speaker Kevin McCarthy that the cushion had been reduced to “days or weeks.”
President Joe Biden has been forced to cancel a travel to the Indo-Pacific for a summit with Australia, India, and Japan, as well as a visit to Papua New Guinea, due to the impending deadline.
