The looming U.S. debt-limit crisis, summed up in 5 points
A standoff over the U.S. debt ceiling has just begun and could become the country’s most consequential political showdown over the coming months.
Treasury Secretary Janet Yellen has announced that the country will hit its debt limit on Thursday and needs to start taking “extraordinay measures” to avoid default.
The rest of the world will have questions — understandably, because in this standoff everyone has a stake.
The Republican Party has the demands, the debt ceiling is the weapon, and the global economy is the hostage.
Here are some answers.
What is the U.S. debt ceiling?
The U.S. Constitution gives Congress power over public finances and Congress has always played some role in setting debt levels. It created the first modern debt ceiling in 1939.
It’s just what it sounds like: a maximum level of U.S. debt. Lawmakers have had to raise it dozens of times in years past.
U.S. debt is owed to people and institutions around the world, two-thirds of them inside the U.S. and one-third abroad. They include any buyer of government-issued securities like bonds and Treasury bills, such as pension funds, mutual funds, regular investors, the U.S. Federal Reserve, or other central banks — with Japan, China and the U.K. atop the list.
The debt ceiling was last increased two years ago to its current level, $31.4 trillion, or more than 120 per cent of the U.S. GDP.
The U.S. will technically hit that limit next week; disaster, however, can be delayed a few months.
Many economists hate this system. In one economist survey, 84 per cent agreed it creates unnecessary uncertainty in the economy.
“I don’t think it makes any sense,” Lee Roberts, who teaches public budgeting at Duke University, said in an interview.
The normal way to set debt levels is the regular budgeting process, he said, where Congress approves spending.
What happens if Congress doesn’t raise the limit?
Bad things. A report by Moody’s Analytics is filled with scare adjectives like “cataclysmic,” “unimaginable” and “devastating.”
Moody’s foresees effects on par with the post-2007 financial crisis: a GDP decline of almost four per cent, nearly six million lost jobs, and stock prices plunging almost one-third.
An older study published by the U.S. Federal Reserve forecast similar, if slightly less dire, results as Moody’s.
Those are short-term effects. A longer-term problem is the new uncertainty permanently embedded in the world economy.
The global financial system is built upon the bedrock assumption that U.S. government-backed securities are a safe and readily available investment asset, Marc Goldwein says.
If there’s a global recession because of this, it’s because that longstanding assumption would be rattled, said Goldwein, an economics professor and vice-president at the Washington-based Committee for a Responsible Federal Budget.
Look at what happened in 2011 during a debt-ceiling standoff: the mere talk of a potential U.S. debt default caused the first credit downgrade in American history which wiped seven per cent from the stock market in one day.
Why are we discussing this now?
Because the limit is looming and conditions are similar to 2011. A perfect political storm: Republicans have the House of Representatives, and they’re ready for a fight with Democrats in the White House and Senate.
Remember the recent melodrama in Congress where it took more votes to pick a speaker than any time since the U.S. Civil War? The debt ceiling played a role.
Several conservative holdouts made demands upon Kevin McCarthy, one of them being that he would drive a hard bargain before lifting the debt limit.
They want spending cuts and see federal deficits as unsustainable. They’re not alone. How many cuts do they want? We don’t know yet.
What we do know is McCarthy has to keep these members happy. Even a small mutiny, of just a few members, could cost him his current dream job.
What actually happens in the coming months?
Don’t think of debt default as a light switch turning on or off. It’s more like a rising tide, growing steadily more dangerous.
We can actually watch that tide roll in: In daily statements, the U.S. Treasury lists its cash flow.
Using that data, the Treasury’s Office of Debt Management decides when to borrow money. It instructs the Bureau of the Fiscal Service to get that money by issuing securities, like Treasury bills and bonds to be repaid later.
As the debt limit is reached, that activity grinds to a halt.
Cash gets tighter, and the Treasury resorts to the “extraordinary measures” Yellen mentioned to cut costs, like deferring contributions to government employee pension funds. This happened in 2019 and 2021, and it’s about to start happening again in the coming days, as the government cash flow dwindles.
Cash keeps getting tighter, with a brief reprieve in the spring as taxpayers send cheques with their annual returns. But the tide keeps rising.
At some point, federal contractors would be informed of late payments.
Beyond that, you might see what happened in California in 1992 and 2009: it sent regular citizens IOUs instead of normal benefit cheques.
By this point the government is doing anything it can before hitting the fiscal equivalent of a nuclear button: defaulting on debt payments.
Without action by Congress, the U.S. would likely face this situation by the fall — what Goldwein calls uncharted territory.
He’s actually optimistic: He doesn’t think we’ll get there.
“I wouldn’t even want to guess [what happens next],” Goldwein said. “Because I don’t think even our politicians are stupid enough to get to that point.”
What are politicians saying?
McCarthy, for his part, says he wants to deal with this soon. He points to a 2019 agreement where the ceiling was lifted in exchange for minor budget cuts.
Republicans say spending must be reined in now, amid exploding debt costs under the triple-whammy of inflation, higher interest rates, and deficits.
The Congressional Budget Office forecasts just paying interest on the debt will cost $2.5 trillion more over the next decade than previously expected. (For context: the U.S. spends, in one single year, under $2 trillion on the military and old-age pensions, combined.)
What Republicans aren’t interested in is reviewing past tax cuts that coincided with worsening budget deficits under Ronald Reagan, George W. Bush and Donald Trump; they want spending cuts from Democrats.
The White House position is: There’s no negotiation. It says Congress has a basic duty to pay bills already incurred, from spending already approved by Congress.
“There will be no hostage-taking,” said White House spokeswoman Karine Jean-Pierre.
That position might prove unsustainable.
The basic reality is the House of Representatives has power here; Republican leaders are being told by their members, in no uncertain terms, to use it.
And the pressure on McCarthy to fight will only grow in the coming months as conservative talk radio and TV warn against caving.
Even President Joe Biden seems to acknowledge it won’t be automatic: he recently alluded to the long days he spent in 2011, including on New Year’s Eve, negotiating a deal to avert that debt crisis. It took almost $1 trillion in spending cuts.
“We’ve always been able to work together,” Biden said.
That deal, however, happened under John Boehner: The then-Republican House speaker had to work to coax enough members to pass it.
Could McCarthy achieve the same?
In his memoir, Boehner mentions McCarthy just one time — castigating McCarthy’s behaviour in that 2011 crisis as weak, saying he failed in his leadership duties and scurried out of the chamber before Boehner could ask why he bailed on a budget deal.
“[That] really pissed me off,” Boehner wrote.
That incident, Boehner said, contributed to him eventually bypassing McCarthy as his heir apparent and convincing Paul Ryan to take the speaker’s job; he said Ryan had shown leadership qualities by standing firm and voting for a budget deal.
Well, here we are again.
This time, McCarthy’s in charge. The hardliners have more control.
Some worried moderates from both parties have already begun preliminary talks about employing a rare parliamentary tactic to bypass McCarthy and force a debt-ceiling vote.
It’s a longshot.
Whatever happens, Roberts hopes there’s a deal, the sooner the better: “Because the consequences are so dire you would hope they would reach a resolution.”