The United States national debt has been growing at a rate faster than the nation’s income for over half a century. According to the US Constitution, all borrowing must be authorized by the Congress. To ensure that the Treasury wouldn’t have to seek permission every time it needed to issue debt, a debt limit was put into effect as part of the Second Liberty Bond Act of 1917. In 1939, a general limit on federal debt was also imposed. On February 19th, 2023, the US government reached its borrowing limit, leading the US Treasury to take extraordinary measures in order to fulfill its debt obligations.
People are growing increasingly concerned about the debt limit in recent times, which prompts the question: what happens if the Congress fails to agree to lift the debt ceiling? The US Department of the Treasury is responsible for paying the US government’s bills, which it does by issuing debt. If Congress does not raise the debt limit, the Treasury may not have enough funds to pay the government’s bills, causing a government shutdown or a financial crisis. It is important for the government to address this issue promptly to avoid any detrimental consequences.
Recently, the U.S. Treasury Secretary Janet Yellen wrote a letter to Congress warning that the debt ceiling would be hit in two weeks. This week, the debt ceiling was hit and the Treasury has been forced to take extraordinary measures to prevent the U.S. from defaulting on its obligations. These extraordinary measures are expected to only buy a few months of time, which means that the Biden administration and lawmakers on Capitol Hill will likely face a showdown in the coming months.
It’s important to note that the debt limit does not authorize new government spending. It simply allows the government to finance legal obligations that they have already committed to spending, obligations made by congresses and presidents of both parties in the past. The spending being discussed has already happened, and the current discussions are only about paying for that spending.
The recent debt ceiling debate has once again brought to the forefront the opposition to high government spending by Republicans. They may use the debt ceiling approval process as leverage to extract promises to reduce future spending and borrowing, possibly even rolling back some spending involved in the recent Inflation Reduction Act. The US Treasury Secretary Janet Yellen warned that failure to meet the government’s obligations would cause irreparable harm to the US economy, the livelihoods of all Americans, and global financial stability.
The debt ceiling debate is not new and has happened multiple times in the past. Investors have become used to the negotiation and threats that typically occur, only for legislators to agree at the last minute. The debt ceiling was increased 90 times in the 20th century, with 18 increases under Ronald Reagan, eight under Bill Clinton, seven under George W Bush, and five under Barack Obama.
When it appears that an agreement on the debt ceiling won’t be reached, the same solutions are put forth to avoid government default. One is for the President to invoke his 14th Amendment authority to pay government bills, and the other is for the government to mint a trillion-dollar coin to refill the general account. A well-known blogger and journalist, Mattie Glacias, recently suggested that the government could solve this problem by issuing Premium Bonds. However, these solutions are legally questionable and lack a permanent solution to the problem.
Will this debt ceiling debate be just another momentary storm in a teapot, resolved with a hashtag trending on social media for a few months before Congress increases the debt ceiling, or will it be different this time? If it is different, it could have an impact on markets.
The recent events in Congress are causing concern among investors regarding the upcoming debt ceiling debate. The House Majority Leader, Kevin McCarthy, failed to be elected as the speaker in the initial round of voting, which happened for the first time in a century. This has raised concerns that the House of Representatives might not be able to reach a consensus on controversial matters, including the debt ceiling.
The concern is not only limited to the division between Republicans and Democrats but also a small group of rebels within the Republican Party that could obstruct the goals of mainstream Republicans. This could result in a Congress unable to reach agreements on critical issues.
However, it is possible that the chaos and drama around the debt ceiling may only cause temporary volatility in the stock and bond markets. In the end, compromises may be made, and a deal could be reached. Nevertheless, the fear of an ineffective Congress is real, and it remains to be seen how the debt ceiling debate will play out in the coming weeks.
The debt ceiling debate has happened several times in recent years and it has mostly ended with a compromise. However, in 2011, the squabbling led to a credit downgrade by ratings agencies, which caused a significant drop in the stock market. On the day of the announcement, the S&P 500 fell 6.7%, marking one of its worst single-day declines in market history. The U.S. Government Accountability Office estimates that the fight over the debt ceiling in 2011 raised borrowing costs for the government by $1.3 billion, and over the next 10 years, the cost increased to $18.9 billion according to the Bipartisan Policy Center.
A potential outcome of this debt ceiling debate is that Congress might use it as leverage to force government spending cuts, which could put pressure on companies whose revenues come largely from the federal government, including defense stocks and infrastructure companies that benefit from the Inflation Reduction Act.
The most concerning outcome, although unlikely, is a default if Congress fails to agree and the US misses an interest payment. Some political analysts believe that this is a possibility, but it is yet to be seen how the situation will unfold.
Mark Zandi, the Chief Economist at Moody, warns that there are senators and congress members openly discussing the possibility of breaching the debt ceiling. If a default were to occur, it could have severe consequences for the United States. In 1979, despite Congress raising the debt ceiling just before a default would have become unavoidable, technical issues with 1970s era word processing equipment used to print checks resulted in the Treasury being unable to get the checks printed on time. Although investors eventually received their payments, with only a small delay, Treasury bill yields jumped 60 basis points on the day of the delay and remained elevated for several months afterward, costing taxpayers in the tens of billions of dollars. This 1979 default, which was driven by a technical issue and not an unwillingness to pay, was only temporary. The Treasury did eventually pay the $120 million shortfall after a short delay, but initially refused to pay the additional interest to cover the period of delay. After some legal pressure and new legislation, the Treasury eventually made all investors whole for that additional interest. It is important to note that this event in 1979 wasn’t considered a real default, but rather a back-office mix-up that only affected a small portion of the nation’s debt, mostly T-bills owned by individual investors.
The United States defaulted in a small and unintentional manner due to a failure to make a payment on time. To avoid repeating this expensive mistake on a larger scale, the Treasury is taking extraordinary measures. To generate additional borrowing capacity and extend the remaining cash, the Treasury has announced that it will suspend new investments in various government accounts and make changes to the Thrift Savings Plan for Federal employees. These funds will be made whole once the debt ceiling situation is resolved. When these measures run out, the Treasury will likely prioritize certain payments to ensure that interest and principal payments on the government’s debt are made and default is avoided.
Federal programs such as salaries for government employees, Social Security, and military healthcare coverage could be at risk during a government shutdown. In previous shutdowns, some employees were asked to work without pay while others were sent home without pay. The National Park Service was also shut down, causing major inconvenience. The process of the Treasury Department choosing who to pay and when to pay would be both costly and put a strain on their financial technology systems, which are not equipped for this situation.
House Speaker Kevin McCarthy, a Republican, had a positive conversation with President Joe Biden last weekend. He expressed his desire to work through the challenges facing the government early on. However, McCarthy is in a weak position within his own party and may face difficulty pushing for compromise among rebellious party members.
After agreeing to a rule allowing any single lawmaker to motion to remove him from his post two weeks ago, various solutions have been proposed to address the issue. One such solution is the minting of a trillion-dollar platinum coin. This idea has been around since the Obama administration’s debt ceiling fights and is based on a modification of the Coinage Act that was passed by Congress. The act gave the US Treasury the authority to mint platinum coins of any denomination, and a trillion-dollar coin wouldn’t need to have a trillion dollars’ worth of platinum in it, but rather could simply be given that face value.
The argument is that the Treasury could mint a trillion-dollar coin and deposit it at the Federal Reserve, which would provide a means for the Treasury to fill up its bank account and continue to make payments without violating any statue or provision of the Constitution. Another suggestion is that the President could invoke the 14th amendment.
The US government has been facing the issue of paying its bills, and several solutions have been proposed to avoid default. In 2011, former President Bill Clinton suggested using the 14th amendment to pay the bills, but President Barack Obama and his lawyers were not convinced of its legality. Another solution is to issue premium bonds with high interest rates, but this would only increase the national debt. The Biden administration has stated that they don’t intend to take executive action without congressional intervention.
However, these solutions are only gimmicks and raise legal and market concerns. Yesterday, Treasury Secretary Janet Yellen confirmed the breach of the debt ceiling and warned of the uncertainty surrounding the extraordinary measures being taken. She has urged lawmakers to act quickly to avoid a possible default, with some estimates suggesting it could occur as early as June. The timing of the debt ceiling depends on various factors such as tax receipts.
In conclusion, the US government is facing a pressing issue of paying its bills and avoiding default. While several solutions have been proposed, they raise concerns and may not be effective. The Treasury Secretary has emphasized the urgency of the situation and the need for lawmakers to act quickly.
