US could default on debt ceiling as soon as June

A fresh warning has been sounded that the US government could default on its debt as soon as June, when the “extraordinary measures” brought in to stave off the crisis are no longer enough to manage a $30 trillion bill that is ticking upwards.

The US will reach its debt limit – which is currently $31.4 trillion – on Thursday, after which the government will begin to rely on a number of “extraordinary measures” brought in to buy it more time.

There was “significant uncertainty” in the debt forecast, Treasury Secretary Janet Yellen wrote to House Speaker Kevin McCarthy earlier this week.

The US treasury would pursue its extraordinary measures – which primarily include changes to the retirement funds of civil servants – but the crisis couldn’t be staved off for long.

In fact, the US could default as early as June, Dr Yellen wrote.

How quickly the money ran out would depend on how much the government collected in taxes this year. Newly introduced policies, such as the student loan forgiveness program, could further shorten the window – but a potential default could cause an economic crisis.

What is the US debt limit?

The US debt limit, also referred to as a debt ceiling, was introduced more than a century ago to limit the amount the federal government was allowed to borrow.

It’s been raised periodically ever since to avoid a default – most recently in 2021, when it was raised to the current level of $31.4 trillion.

The debt is owed to people and institutions around the world, one-third of whom are outside the US. They include any buyer of government-issued securities like bonds, as well as the US Federal Reserve and other central banks – with Japan, China and the UK atop the list.

When the US government comes close to the ceiling, numbers can be crunched to buy a little more time, such as the “extraordinary measures” Dr Yellen said would be introduced in coming weeks.

Eventually, however, the accounting tricks run out, and the debt ceiling can’t be avoided – it has to be raised, or chaos erupts.

What happens if the US defaults on its debt?

If the US were to default on its debt, economist generally predict chaos would ensue.

Goldman Sachs last month warned that a mere close call could set off turmoil on Wall Street, devastating the retirement accounts and investment portfolios of everyday Americans.

“It seems likely that uncertainty over the debt limit in 2023 could lead to substantial volatility in financial markets,” Goldman Sachs economists wrote.

A failure to raise the debt limit in time would “pose greater risk to government spending and ultimately to economic growth than it would to Treasury securities themselves,” they said.

The shifting of funds to avoid a crisis could impact other payments, including social security and veterans’ benefits, Goldman Sachs added, saying “a failure to make timely payments would likely hit consumer confidence hard.”

A recent report by Moody’s Analytics, too, described the possibility the US could default on its debt as “devastating” and “unimaginable”.

They predicted six million jobs would be lost, the country’s GDP would decline by almost four per cent, and stock prices would plunge by almost one-third.

Longer term, however, a default could permanently embed uncertainty into the world economy, devastating the assumption that the US government is a reliable body in which to invest.

In 2011 – the last time the debt ceiling debate looked particularly dire – mere talk of a default caused the first credit downgrade in US history, wiping seven per cent from the stock market in a single day.

In her letter to Mr McCarthy, Dr Yellen urged politicians to “act in a timely manner” either to increase or suspend the debt limit.

“Failure to meet the government’s obligations would cause irreparable harm to the US economy, the livelihoods of all Americans, and global financial stability,” she wrote.

Why does the US have a debt limit?

Many politicians are opposed to having a debt ceiling at all.

Democratic Senator Elizabeth Warren, for instance, has said she would “get rid of the debt ceiling altogether”, claiming it “serves no function except to create leverage”.

In one survey, 84 per cent of American economists agreed it created unnecessary uncertainty.

Texas Republican Dan Crenshaw, on the other hand, called the debt limit a “necessary evil”.

“It’s the only time that you can actually negotiate ways to get out budget under control,” he said.

Many countries have racked up considerable debts over the pandemic, including Australia, where the national debt is just shy of $1 trillion. Australia previously had a debt ceiling of $300 billion, which was abolished in 2013.

Raising the debt ceiling doesn’t necessarily make way for yet more government spending. Typically, it is only done so that Congress can repay the bills the US already owes.

How is the debt limit raised?

The battle to raise the limit will likely be the US government’s most dominant showdown for months, and could paralyse Congress until a compromise can be reached.

It’s expected to unleash a vicious battle between Republicans and Democrats – one of the first since Republicans took control of the House last year.

Republicans would not allow “spending money wastefully”, Mr McCarthy promised, as Democrats insist no spending cuts can be made.

In his fight to become House speaker, Mr McCarthy pledged to deliver a proposal to tackle the debt ceiling by the end of March. He also agreed to allow any member to call for a motion to vacate the speaker’s chair – adding yet more fuel to the fire.

Mr McCarthy insisted he had a “very good conversation” with US President Joe Biden about the debt ceiling, saying: “I told him I’d like to sit down with him early and work through these challenges.”

White House press secretary Karine Jean-Pierre called for co-operation between the two parties.

In the past there had been “a bipartisan co-operation when it comes to lifting the debt ceiling, and that’s how it should be,” she said, adding that the ceiling “should not be a political football”.

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