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The debt ceiling: Could America really run out of money?

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Democrats and Republicans are locked in a stalemate over the 'debt ceiling', a government borrowing limit. Can America pay its bills?
Debt ceiling

Democrats and Republicans in the U.S. are locked in a stalemate over a government borrowing limit called the “debt ceiling”.

Partisan gridlock in the U.S. isn’t new, but this time the consequences might be: for the first time in history, the U.S. Government may not be able to pay its debts.

Government officials say this would unleash a “catastrophe” on the world. Here’s what you need to know.

What is the debt ceiling?

Governments can finance their spending in two ways: by raising money (tax) or borrowing it (debt). Every country in the world does a bit of both.

Debt can be a useful tool if the borrowed money is spent in ways that make a country richer. On the other hand, large amounts of debt can be expensive to repay and burden future taxpayers.

The U.S. Government has a legal limit on its debt, called the “debt ceiling”. It is one of only two developed countries with such a limit (the other is Denmark).

Hitting the debt ceiling

If the U.S. Government hits the debt ceiling, it is prevented by law from borrowing any more money.

The Government would then be limited to spending only what it can raise in tax. It may have to suddenly cut back on spending and may fail to pay back its debts. That’s called a ‘default’. It would be a serious hit to U.S. credibility.

The U.S. has never defaulted before. Congress can change the debt ceiling by passing a law and has done so 78 times since 1960 to avoid this situation.

Current Situation

The current debt ceiling is $31.4 trillion. It was actually hit in January, but the U.S. Treasury has been able to use special arrangements to keep afloat.

Now time is running out. Treasury Secretary Janet Yellen has warned the Government may run out of money by 1 June. Earlier estimates had suggested the Government had until September.

In a letter to Congress this week, Yellen said it was “imperative” that a law be passed to alter the debt ceiling.

Stalemate

The House of Representatives (one of the two houses of Congress which must vote to pass a law) is controlled by Republicans.

President Joe Biden (a Democrat) has demanded the House raise the debt ceiling without conditions. Republicans, led by Speaker Kevin McCarthy, have refused.

Instead, they proposed a bill which would raise the ceiling in exchange for slashing spending. The bill would scrap Biden’s plan to cancel student debts, slash climate-related funding and put tighter restrictions on welfare.

The Republican bill passed the House of Representatives but will not be voted on in the Democrat-controlled Senate.

After previously refusing to negotiate, there are now reports Biden has invited Republican and Democratic leaders to the White House for negotiations.

It’s unclear whether an agreement can be reached. Speaker McCarthy was narrowly elected to his leadership role and faces pressure from the conservative wing of his party.

U.S. Consequences

If an agreement is not reached, the U.S. would be in unfamiliar territory. The domestic consequences would be severe.

When preparing for a possible debt ceiling breach in 2011, the Obama Administration had a plan that would have seen the Government delay welfare payments so it could keep paying back its borrowers.

Such a plan would likely unleash legal challenges. The Government would face contradictory legal obligations: unable to borrow on the one hand, but required to spend by law on the other hand.

A trillion-dollar coin?

Some unusual alternatives have been proposed. One is that the Treasury should ‘mint’ a one-off trillion-dollar platinum coin and give it to the U.S. Central Bank as a way to pay back its debts.

Another is that the Treasury could simply ignore the debt ceiling because the U.S. Constitution states the “validity of the public debt of the United States… shall not be questioned”.

However, either option is likely to bring its own complications and would likely not avoid financial instability and uncertainty.

World recession?

The U.S. is at the centre of the global financial system, so the fallout of a U.S. default would be felt around the world.

In the past, economic turbulence in the U.S. has unleashed a global recession (downturn), most recently the Global Financial Crisis of 2008 which began in the U.S. housing market.

A U.S. Government official has warned a U.S. downturn would spark “a global downturn of unknown but substantial severity”.

 

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