The US Treasury Secretary Janet Yellen on Thursday said that she and her department are taking measures to prevent a default on government debt as the US touched its debt ceiling.
The debt ceiling of the US is $31.4 trillion and the US has touched that mark on Thursday. Yellen said she would take extraordinary measures to prevent the US from defaulting.
But, what is the debt ceiling and how does it impact the American and the global economy?
According to a report by CNBCthe debt ceiling is the amount of money the US Treasury Department is allowed to borrow in order to pay its bills. The Treasury Department with the borrowed money pays Social Security and Medicare benefits, tax refunds, military salaries and interest payments on outstanding national debt, CNBC explained.
Now that the US has touched the debt ceiling, it cannot increase its debt limit and paying these benefits as well as interests on national debt becomes harder.
Why is the debt ceiling an issue?
The debt ceiling is an issue because the American economy’s revenue i.e. tax proceeds exceed the costs of running the country. The US, according to the CNBC report, has not run an annual surplus since 2001 and it has borrowed to fund the running of the government, the report said citing data from White House Council of Economic Advisers.
Another issue is – default. There are fears that the US may run into a default and run out of funds to meet its financial obligations in a timely manner. The report outlined that if the US defaulted on its debt obligations, it could fail to pay investors who have purchased US Treasury bonds which are issued by the Treasury Department.
According to the website InvestopediaJapan, China, the UK, Ireland and Luxembourg are the top five foreign nations who are the largest foreign holders of US debt.
Has the Debt Ceiling Been Raised Earlier?
Yes, the debt ceiling has been raised at least 78 times by Democrat and Republican administrations since 1960. It was raised thrice in the last six months. On December 16, 2021, the Treasury Department oversaw the largest dollar amount increase of the national debt as it raised the debt ceiling by $2.5 trillion to $31.4 trillion.
Has the US defaulted on its debt obligations earlier?
Yes, in 1979, but it was due to a technical glitch in the bookkeeping system. It was corrected immediately.
What Happens if the US Defaults Now?
There will be major repercussions. The impact will barely be noticeable now. Yellen said that to free up cash, new investments in the Civil Service Retirement and Disability Fund and the Postal Service Retiree Health Benefits Fund will remain suspended until June. It can also spend revenues that will be coming in as the tax season begins next week and pay social security benefits, pay defence contractors and other federal workers.
But this is until June. If the debt ceiling is not raised by then, the economic catastrophe will hit, as it did in 2011, when the US was under the Obama administration.
A similar tug-of-war began between the Republicans and Democrats over spending. Currently the Republicans who control the House are pushing the Biden administration to slash government spending, which according to them has risen in an extraordinary fashion. In 2011, former US president Barack Obama and his administration also faced a similar challenge.
The clash in the US Congress in 2011 saw credit rating agency S&P downgrade US’ credit rating for the first time in history. It also leads to government shutdowns. In 2013, Republicans in an attempt to defund the Affordable Care Act (ACA) by leveraging the debt ceiling led to 16 day shutdown.
The Republicans are making similar demands now, weeks after they elected Kevin McCarthy as House Speaker. Their demands are simple – reduce spending and we shall think about raising the debt ceiling.
In case they do not, obligations like social security, payments to defence contractors, military and government employees salaries will go unpaid. Stock markets across the globe will see an uproar. A report by BBC said that even weather forecasts could be affected.
Yellen said that the raising of the debt ceiling will not cost taxpayer money or not authorize new spending but speaking to AFP, Leonard Burman and William Gale of the Urban-Brookings Tax Policy Center said that if the debt limit is not raised then “the amount of spending cuts or tax increases that would be required would equal $1.5 trillion this year or more in the next decade.”
US debt is heavily traded and viewed as low risk, a default would cause ‘irreparable damage’ to that image. The public would suffer because interest rates for mortgages, credit card debt and other loans will soar. The US dollar would also weaken.
“Failure to meet the government’s obligations would cause irreparable harm to the US economy, the livelihoods of all Americans and global financial stability,” Yellen was quoted as saying last week by the BBC.
On Thursday, Yellen urged the Republicans to consider raising the debt ceiling once more.
“I respectfully urge Congress to act promptly to protect the full faith and credit of the United States,” said Treasury Secretary Janet Yellen in a letter to Congressional leadership, according to a report by AFP. Yellen again warned of ‘considerable uncertainty’ regarding the impact of the measures.
The warning from JPMorgan Chase CEO Jamie Dimon was much starker. “We should never question the creditworthiness of the United States government. This is sacrosanct,” Dimon was quoted as saying by CNBC.
Read all the Latest Explainers here