The debt ceiling is the maximum amount of money that the United States can borrow cumulatively by issuing bonds. The debt ceiling was created under the Second Liberty Bond Act of 1917 and is also known as the debt limit or statutory debt limit. If the US governments national debt levels bump up against the ceiling, then the Treasury Department must resort to other extraordinary measures to pay government obligations and expenditures until the ceiling is raised again.
Essentially, it’s all about how much money the US Treasury can borrow. To borrow this money, it issues securities. These securities will eventually have to be paid back, with interest. Should the US Government hit the debt ceiling, the taps would run dry, and it would not be able to raise any more money, nor service some existing debt.
The US Congress is in charge of setting the debt limit, which currently stands at $31.4tn. The debt ceiling has been raised 78 times since 1960, under both Democrat and Republican administrations.
Why is the debt ceiling in the news?
Simply put, because the ceiling may well be reached in the 1st week of June 2023. Should it not be raised or suspended, the US could default on some of its debt. US debt, which is widely considered as the safest debt available, could suddenly be rendered ‘risky’. This would be calamitous for the US market and, more broadly, the global economy.
Why would a default be calamitous?
“Failure to meet the government’s obligation would cause irreparable harm to the US economy, the livelihoods of all Americans and global financial stability,” the US treasury secretary, Janet Yellen, said in a letter to Congress earlier this year.
Repercussions may include a loss of faith in the strength of the US Dollar, job losses, housing declines, and a flight from US Treasuries leading to surging and expensive yields. Because of the vast interconnectedness of the global economy (as we witnessed during the Global Financial Crisis), a US default would send shockwaves throughout the global economy.
What is the state of play?
Republicans in the House passed a bill on the 26th of April that would raise the debt ceiling by $1.5tr, but simultaneously mandated spending cuts of $4.8tr over the next ten years. Democrats are refusing to negotiate the debt ceiling as they are accusing the Republicans of using the impasse to usher in austerity measures.
“Still, Republicans seem adamant on using the high-stakes timeline toward default to pressure Democrats into agreeing to spending cuts. They did this successfully in 2011, when Democrats agreed to spending cuts 72 hours before the government defaulted. This time around, with neither side budging, a continued stalemate could bring the US economy closer to disaster” – The Guardian.
In a world full of uncertainty (war, inflation, interest rates, the COVID-19 pandemic), investors tend to seek reassurances from the market. Gold, for instance, has historically been a good hedge against inflation. US Debt is somewhat similar in that it has stood the test of time for well over two centuries. A default by the US would cause fissures to spread through the very bedrock of the global economy. It simply isn’t a road we want to walk down. One hopes that common sense will prevail, and the US will put aside partisan politics and do what is necessary to keep the global economic cogs turning.
From the desk of Stewart Dando (AMA Intentional Chief Investment Officer)