February 5, 2023

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The US will hit its debt ceiling on Thursday.  What is going to happen?

The US will hit its debt ceiling on Thursday. What is going to happen?

Bankers, investors and policy makers can already take this into account in their vacation plans for the summer: stay close to home from June, and above all easy access. A new battle over whether or not to raise the ceiling on the US national debt Credit limit, a war may arise from that month. With major consequences for American society and financial markets in all corners of the world.

Congress has had the final say on the level of the debt since 1917, when the United States entered World War I and concerns arose that the national debt would grow too high. That approval has long been a hammer piece. But over the past quarter century, as political polarization has increased, such a fiat is no longer self-evident.

Once a president faces a Congress with opposition majorities in the House of Representatives, the Senate, or both, raising the debt ceiling has now begun to demand far-reaching political concessions. During midterm elections in the United States, the debt limit is a regular point of debate, as an incumbent president usually faces a majority opponent in Congress.

A succession of crises

That regulation is enshrined in the rules. Many countries, including the eurozone, follow policies based on the relative size of government debt: the share of that debt in the economy, relative to GDP. If the economy grows, the national debt grows with it, because the costs of that debt (when interest rates remain the same) remain proportionally the same.

However, the U.S. debt ceiling uses an outdated measure: the absolute amount of that debt, in billions of dollars. If the economy grows and government spending grows with it, the national debt in dollars will increase. If inflation occurs, the national debt in dollars also grows. If the budget deficit keeps pace with economic growth, the national debt in dollars will increase anyway.

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This, in short, is a recipe for a very regular increase in the debt ceiling. So crises often occur. In particular, in a difficult compromise in Congress, the agreed-upon increase is always so small that the new ceiling will soon be reached again.

When government bonds are called into question, the rug is pulled from under the global financial system

The latter certainly exists now. 2022 is a year of relatively high economic growth, massive inflation and a budget deficit of more than 4 percent of GDP. All these contribute to a significantly higher absolute national debt. Not surprisingly, the $31.381 billion new debt ceiling that took effect 13 months ago has already been exceeded. In that vast year, government debt totaled $2,900 billion.

Last Friday, Treasury Secretary Janet Yellen wrote in accordance with the procedures A letter to Kevin McCarthy, the new Republican speaker of the House of Representatives, with advice to raise the ceiling. Because she estimates that it will be broken on Thursday, January 19.

Cash position measurements

Considering previous debt ceiling crises, a reasonably good scenario can be outlined for what will happen now. First, cash flows for health care costs and pension funds for government employees, such as postal service workers, are frozen and promised to be paid later. Expiring government bonds in which these funds invest are also not temporarily replaced by new ones.

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At the same time, the central government can enjoy its cash position for a little while longer. But in June, Yellen estimates those measures will work. Then the temporary shutdown of government services and deferment of salaries begins. That’s when the White House and the House of Representatives start blaming each other for the harms to society.

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It usually ends at the edge of that valley. But not always. In 2011, under President Obama, the battle intensified to the point where rating agencies downgraded America’s ‘Triple A’ credit rating for the first time in living memory. It was so threatening that a compromise was still reached.

The fact that there’s always a way up until now means that financial markets are relatively quiet at the moment. But let’s assume America misses even one interest payment soon. That would be a major blow to the international financial system. Because US government bonds, Treasuries, is an indisputable foundation. They provide the ultimate safe investment, collateral in countless contracts, official exchanges and liquidity for mutual trade. And that’s all over the world.

Investigating them could rip the rug out from under the global financial system and unleash a major crisis there. In theory, as the Obama administration has already discovered, the US Treasury Department could use a loophole to mint a massive $1,000,000,000 megacoin. But whether it survives practice is highly questionable.