In the realm of financial acrobatics, where gravity-defying feats of fiscal responsibility and political maneuvering collide, one spectacle never fails to captivate audiences around the world: the US Debt Ceiling Debacle. And like the classic United States of America that it is, it never fails to give the world audience what it wants.
You might have heard this line “When the United States sneezes, the whole world catches a cold.” And this has been seen in the history of the financial world. From the 2008 housing market crisis to the failing of US banks, the world along with the United States also faced many challenges like recessionary pressures in their economy and their currency slipping down. And now the world has to embark on a journey of topsy-turvy world of American fiscal policy, where the debt ceiling looms large like a daunting tightrope, threatening to send the nation - and the global economy - into a heart-stopping freefall.
Source:- https://www.cnbc.com/2023/02/15/debt-ceiling-us-is-projected-to-default-between-july-and-september-if-congress-doesnt-raise-limits-cbo-says.html
Let’s take a historic context first. Back in the year 1557, Spain became the first country to default on its debt. Since then, it has roughly defaulted around 15 times on its debt. Then there are other Latin American and Asian countries like Mexico and Russia who have also defaulted on their debt. Interestingly, in the year 1840, United States also defaulted on its debt as they built too much infrastructure too fast, especially canals,
and they defaulted on their debt and it became a big problem for them.
But post World War II, the US rose in economic prominence, and since then, it has never defaulted on its debt. Now, in the year 2023, talks are going on that the US will be unable to increase its debt ceiling. Therefore, it will default on its debt and it will be catastrophic for the entire world.
Debt ceiling:-
That brings us to the question, what is a debt ceiling? So let's understand it with a simple example. Let us suppose that the US government is a shopaholic with an insatiable appetite for spending, racking up a considerable amount of debt over time. To ensure that spending doesn't spiral out of control, a statutory limit on how much debt the government can accumulate is imposed - the infamous debt ceiling. It's as if Uncle George sets himself a financial red line, beyond which he cannot venture without explicit permission.
What U.S government is doing right now is that they are trying to increase this debt ceiling limit so that they can borrow more. Because of course the US believes that defaulting on debt is not an option.
Source:- https://www.sc.com/en/grow-your-wealth/positioning-for-us-debt-ceiling-showdown/
The US Treasury uses tax revenue and debt to pay the country's bills like funding government programs, social security, and paying interest on existing debt. If it runs out of money and isn't able to pay these investors back, that's default, and that's what will happen if Congress doesn't raise the debt ceiling to allow the Treasury to take on more debt.
This could cause a massive financial catastrophe with stock prices falling, interest rates rising to new levels and probably the dollar falling too. And the worst case scenario is it could cause a whole new recession.
The concept of the debt ceiling emerged in 1917 as a tool to enhance congressional oversight over the country's borrowing. Its original intent was to ensure responsible fiscal management by capping the total amount of debt the US government could accumulate. However, over time, the debt ceiling has evolved into a political bargaining chip, giving lawmakers a platform to push for policy concessions and ideological goals.
Now one may think that the US government could easily increase the debt ceiling and yes they did, not once or twice but 78 times since the 1960’s.
As of now the US in total has roughly $31 trillion of debt with holdings of approximately $9 trillion of debt by the foreign investors and institutions. Most of the debt held by the US is domestic.
Source:- https://www.visualcapitalist.com/rise-of-americas-debt-ceiling/
Implications of rising debt ceiling:-
As the debt ceiling of the United States reaches new heights, it casts a long shadow over the nation's economic landscape, triggering a cascade of implications that reverberate far beyond the halls of Congress.
The implications of a rising debt ceiling are vast and multifaceted, touching upon fiscal stability, interest payments, generational equity, economic growth, and inflationary risks.
Mounting fiscal burden:-
The US government generally raises money in the form of bonds. They raise the money and pay the investors interest every year or month and when the maturity date of the bond comes, they pay the whole principal amount along with the interest payment for that year or month.
The government wants to borrow more money so that they may take care of their defense and military expenditure, pay infrastructure or education related bills, manage their working capital and other day to day activities.
So if they keep on getting more debt, they are keeping on accumulating more interest payments which can lead the US government to either increase its tax revenue or cut down on their expenses, both of which the US citizens will not favor. The total or gross federal debt is $31.5 trillion right now.
Source:- https://upload.wikimedia.org/wikipedia/commons/thumb/d/dc/Federal_Government_debt.webp/1920px-Federal_Government_debt.webp.png
Higher Interest Payments:
With a higher debt ceiling, the government must borrow more money, leading to increased interest payments. The rising interest costs contribute to the overall budget deficit, potentially leading to a vicious cycle of borrowing to cover existing debt obligations.
The US bonds are considered to be the safest investment on earth. Hence they have to pay a subsequently lower interest rate. Lower the risk, lower are the returns. Companies such as Microsoft who have an AAA rating are considered to be very safe and hence they give out less interest rates. On the contrary companies such as Credit Suisse paid as high as 10% on some riskier bonds which were wiped out of the market when the bank failed.
Source:- https://upload.wikimedia.org/wikipedia/commons/thumb/d/d0/Interest_on_the_debt.webp/1427px-Interest_on_the_debt.webp.png
In 2011, the S&P downgraded the US credit rating by one notch, to AA+ when the government came within hours of defaulting on some of its obligations. But it didn't gain much investor attention as only one of the credit rating companies gave them those bad points. But this time it is quite a different scenario. The so-called “big three” — Moody’s Investors Service, S&P and Fitch Ratings — hold immense power to determine the creditworthiness of companies, state governments and even entire nations. All three agencies have signaled that they would consider cutting the United States’ credit rating if lawmakers do not pass a bill to raise the debt limit before it’s too late. In fact, earlier this week, Fitch issued a stern warning, placing top-ranked US credit on ratings watch negative.
So if the bonds credit ratings goes down, the interest rates would just go up costing the US government a hefty amount of payments.
Pressure on Future Generations
Raising the debt ceiling today means passing on the burden to future generations. As the national debt accumulates, it becomes an intergenerational issue, with younger cohorts facing the prospect of inheriting a substantial debt load.
This burden may limit their opportunities, placing constraints on future economic growth, and impeding their ability to invest in critical areas such as education, innovation, and infrastructure.
A continuously rising debt ceiling can have adverse effects on economic growth. High levels of public debt can crowd out private investment, as government borrowing competes for available funds in the financial markets.
Reduced investment can lead to lower productivity, sluggish economic expansion, and diminished job creation. This can hinder long-term prosperity and impede the nation's ability to compete globally and will also increase the dependence on foreign investors.
Inflationary Pressures
If the debt keeps on increasing the interest cost will also keep on going higher and higher and that is the reason why the government will have to divert some funds maybe from infrastructure, defense, education or medicine to cater to the interest payments and if such a thing keeps on going then this may lead to an overall economic imbalance leading to more inflation and more taxes.
Which brings us to the point where President Joe Biden definitely understands the gravity of the situation and that is the reason why he recently canceled the Quad Summit just to resolve this issue as soon as possible.
An also significant concern stemming from a rising debt ceiling is the potential for inflationary pressures. When the government resorts to increased borrowing to finance its debt, it injects more money into the economy. If not carefully managed, this expansion of the money supply can fuel inflationary trends, eroding the purchasing power of individuals and businesses and destabilizing the overall economy.
The US media and the concerned people with the issue came with all sorts of remedies to not default on debt, that they were willing to mint a $1 trillion platinum coin and issue premium bonds. But we all know that these measures are all risky and can take the economy to a deathbed.
The US was facing a cash crunch for months and they could've defaulted on their debt on 1st June, 2023 which could’ve been a massive economic spillover all over the world. So how did they stop that from happening?
Well after a long debate of whether they will default or they will not default, the United States has now suspended its debt ceiling and prevented a default but for the short term.
US President Joe Biden on 3 June,2023 signed into law a debt ceiling bill passed by Congress after weeks of wrangling, moving to avert a catastrophic, self-induced default in the world's biggest economy.
Source:- https://www.equitypandit.com/us-president-biden-signs-debt-ceiling-bill-announces-it-in-his-first-oval-office-address/
The Fiscal Responsibility Act of 2023 authorizes the government to extend the so-called debt ceiling to renew borrowing, keeping the bills paid. The Treasury had warned that if the debt ceiling was blocked beyond 5th June, the country would default on its $31 trillion debt.
So the conclusion to it all is, the US being the superpower it is, has stalled itself from defaulting on debt today. But it will bound to happen someday.
"We averted an economic crisis," President Joe Biden said.
Article by:- J Shree Nidhi
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