Should we be worried about the US debt ceiling?
The US debt ceiling is back in the headlines once again, as the US hit the cap earlier this year. Should the debt ceiling be breached, we may see reduced global trade, financial instability, and a slowdown in economic growth.
For those who are not familiar with what the US debt ceiling is, it is simply the total sum of money that the US government can borrow to fulfill its existing financial obligations. This includes Social Security and Medicare benefits, military salaries, tax refunds, and interest on the national debt, among others. Currently, the US debt limit is set at USD 31.381 trillion.
But why is it an issue now?
Well, as the country hit its debt ceiling last January 19, US Treasury Secretary Janet Yellen said that the US government would resort to “extraordinary” measures to avoid going over or breaching the cap and to buy time for Congress to hopefully raise the limit.
Since hitting the limit, the US has been using whatever available funds and managing spending to avoid default without issuing new debt, as the latter would mean breaching the cap. This includes putting on hold investments and contributions in retirement and health care plans for federal employees.
However, these extraordinary measures could not be used indefinitely. According to Yellen, the US might run out of cash and could default as early as June 1, the x-date, if the debt ceiling is not lifted or suspended.
This means that there are only enough funds to accommodate reduced government expenses up to the x-date. Thus, the Democratic-controlled Senate and the White House want the cap raised or suspended by June. Note that raising the debt ceiling would not allow the US to incur any new spending; it would only permit them to meet existing obligations.
Demands of US Congress
The Republican-led House of Representatives passed a bill late April outlining that they would allow the debt ceiling to be raised in exchange for spending cuts, among which are healthcare for the poor, budget for air-traffic controllers, and tax incentives for solar and other climate-friendly energy sources. The bill would necessitate spending cuts worth USD 4.5 trillion in exchange for a USD 1.5-trillion increase in the US debt limit.
US President Joe Biden, on the other hand, has emphasized that Congress must raise the debt limit with no further negotiations, but that he is amenable to discussing budget cuts after the new limit has been approved.
Repercussions on the global economy
Failure to raise the debt limit or a US debt default may pose negative implications not just to the US economy but to the global economy.
- Cut in government servicesThe country would need to continually pay for entitlement programs such as Social Security but would have limited space to borrow to pay for these initiatives. The government would then have to prioritize which programs to continue and hold off funding for new ones.
- Investor wariness over government securitiesMarket uncertainty over the government’s ability to pay for its debt would also make investors more cautious about holding US Treasury bonds. Because of this, prices of bonds would drop, and yields would climb in order to make these bonds more attractive to investors. This would then result in higher interest rates as the yield on US treasury bonds is used as a benchmark for other interest rates. Higher mortgage rates and borrowing costs would then lead to heightened inflation.
- Dollar depreciationThe US dollar would experience a sharp drop in value compared to other currencies as the demand for the US dollar decreases, leading to increased import prices and elevated inflation. Other countries might also lessen their dependence on the US dollar as the international reserve and trade currency.
- Impact on tradeA default would also make it harder for the US to obtain trade deals with other countries, and trade barriers in the US might be initiated, which could negatively businesses, reduce exports, and affect the global supply chain. The US would then decrease its trade activity, which would slow down growth, likely affecting other countries, too.
Again, the most extreme of these scenarios will happen only if the US actually defaults on its debt, or if the debt limit is not suspended or raised. The silver lining is that, historically, the US has never truly defaulted on its debt obligations.
The most recent close call over the debt ceiling was in 2011 when the congress approved increasing the ceiling just two days before the expected x-date. As a result, Standard & Poor’s (S&P) downgraded the credit rating of the US, and risk assets performed unfavorably: the dollar weakened, stock prices fell, and credit spreads widened. Other debt ceiling showdowns in the US have also led to interest rate spikes.
This issue is more than just about the debt ceiling as there is a political gridlock that needs to be addressed as well. Hopefully, talks or negotiations between the US Congress and the Biden administration will be settled before the x-date to avoid the dire repercussions that may spread from the US to the global economy as well.
ANNA ISABELLE “BEA” LEJANO is a Research & Business Analytics Officer at Metrobank, in charge of the bank’s research on the macroeconomy and the banking industry. She obtained her bachelor’s degree in Business Economics from the University of the Philippines School of Economics and is currently taking up her Master’s in Economics degree at the Ateneo de Manila University. She cannot function without coffee.