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The US reaches its debt ceiling again: what it is and why it worries the markets

Date: June 10, 2023 Time: 13:32:48

The United States achieved its debt ceiling last Thursday, which makes the country prepare for an intense scenario: a possible confrontation in Congress and the possibility that the government has to assume the ‘default’ (non-payment) of some bonds in just a few months. Treasury Secretary Janet Yellen notified lawmakers of this milestone, warning the week before, due to its great importance to the country.

The debt ceiling, a legislative device that puts a ceiling on the accumulated indebtedness of the State, currently stands at 31.4 trillion dollars and, unless Congress increases it, the government will run out of liquidity. In theory, reaching that level would lead to dire economic circumstances. All federal government spending would come to a sudden halt: Medicare, Social Security, Washington civil servants, and military salaries, to name a few.

But it could be even worse. It could mean the government not paying interest on bonds already issued, which would be considered a credit event that could increase borrowing costs for years to come. The additional interest payments could cost thousands of millions of dollars. In practice, none of this is imminent.

The Joe Biden government is financed by a combination of bond sales and tax receipts. Yellen said the Treasury Department will suspend debt issuance and begin using “extraordinary measures” from an accounting standpoint to allow the government to continue paying its bills. “I respectfully urge Congress to act promptly to protect the full faith and credit of the United States,” the country’s chief tax officer said in the letter.

United States government bonds are traded around the world as the lowest-risk asset denominated in dollars, the international reserve currency. If the US government is seen as unreliable in paying its debts, it would send a very negative signal to the entire global financial system.

So far, however, credit ratings firms have not sounded the alarm on US government bonds. Last week Moody’s commented that it expects Congress to reach an agreement on a new debt ceiling to avoid a credit event, but watch for possible negative effects on financial markets.

89 Debt Ceiling Raises

“A deal is likely to be reached only very late or gradually, which could contribute to increased volatility in financial markets,” Moody’s said in a report. But the agency expects a deal because of the “potentially serious consequences a late payment could have on markets and the economy.”

History supports his thesis. Since 1959, legislators – it does not matter if they are Republican or Democrat – have raised the ceiling up to 89 times, according to data from the Peter Peterson Foundation. The last time was in December 2021, when Biden himself sold a greater than 2.5 trillion dollars, up to the current 31.4 trillion.

The debt ceiling is a quirk of the US legal system, most countries do not have one. It creates the situation where Congress has to vote once to pass legislation that requires funding, and then has to vote again to approve funding to carry out your wishes.

The cap was first introduced in 1917 to allow the government to sell more bonds during World War I. It was repeatedly raised without much fanfare, and in 1979, Congressman Dick Gephardt introduced a rule of thumb that caused the debt ceiling to be automatically raised each time the budget was passed. That rule, however, was repealed in 1995 in the midst of the so-called “Republican Revolution” led by Newt Gingrich, creating the opening for the clashes over the issue seen in recent years.

In 2011, with Barack Obama in the White House, the United States narrowly avoided not being able to pay its bills, resulting in a response from credit rating firms. Standard & Poor’s downgraded its US debt rating for the first time in history, placing it one notch below the highest AAA rating. Moody’s and Fitch did not downgrade the Treasury bonds, but they downgraded the debt outlook to “negative” – which implies future rating downgrades – that year.

The United States could be in a phase of carrying out a risky policy. Republicans say they want budget cuts before the ceiling goes up. House Speaker Kevin McCarthy reportedly promised House Republicans who delayed his term as president that he would not accept a cap increase without significant spending cuts or other tax reforms.

The White House keeps saying it will not negotiate. “There will be no debt ceiling negotiations,” said Senior Deputy Press Secretary Olivia Dalton. “Congress must address this without conditions,” she added. Oregon Democratic Sen. Ron Wyden, chairman of the Senate Finance Committee, said in a tweet that cutting Medicare and Social Security in exchange for raising the debt ceiling is “a gimmick” and “a failure” for Democrats. . Meanwhile, Senate Minority Leader Mitch McConnell described that he was not concerned about the matter for now, according to the Associated Press.

Will the blood reach the river?

For their part, Wells Fargo economists Michael Pugliese and Karl Vesely specified in a note that “given the dynamics at stake, they believe that the probability of a prolonged and potentially serious debt ceiling confrontation is high compared to with similar episodes in the past.”

S&P Global Ratings affirmed its ratings on the sovereign debt of the United States. “We expect key economic policies to remain stable and largely predictable,” the agency’s senior credit analyst Joydeep Mukherji wrote in a note. “Despite many years of polarization, the executive and legislative branches of government have demonstrated their ability to pass crucial legislation based on last-minute compromises,” he added.

One argument for having a debt ceiling is that it gives investors confidence that government borrowing will not get out of control. There is only one real-world obstacle to a government borrowing an infinite amount of the money it can print: bond markets. If borrowing increases too much, investors will ultimately demand higher returns, eventually making it too costly for the government to issue debt.

Puck Henry
Puck Henry
Puck Henry is an editor for ePrimefeed covering all types of news.

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