- At the beginning of the year, the debt of the world’s leading economy reached a peak of $31.4 trillion.
- Since then, government spending has been executed through the Treasury Department’s emergency funds.
- But the Treasury’s backstop is not permanent and the funds could run out in early June.
On January 18, 2023, the debt ceiling in the U.S. economy was reached. As such, government spending exceeded the then current limit of $31.4 trillion. The country’s government budget was exhausted and accessing more funds required either raising the debt limit or spending less.
These two points sum up the current debt problem, which could lead to a devastating default. The White House wants to raise the limit, but that requires approval from the GOP-dominated Congress. At the other extreme, conservatives make raising the limit conditional on cuts in government social spending. These are two diametrically opposed visions.
The Biden administration considers it unacceptable to cut its social programs, as these are two of its campaign banners. While this controversy is going on, the country remains in official default mode and the debt is supported by a limited emergency plan from the Treasury Department.
Treasury funds will run out any time in early June, according to the chief herself, Janet Yellen. As a result, while the situation hangs in the balance, the parties have not made a modicum of progress on the debt limit. The specter of default looms on the immediate horizon.
Debt ceiling negotiations at a standstill
The fact that there is no agreement between Republicans and Democrats to raise the debt ceiling is troubling. This is according to House Speaker Kevin McCarthy. Speaking to CNBC on Tuesday, the conservative lamented the lack of progress in the talks. “I’m always optimistic, but at this point I’m not,” he noted.
The crux of the problem is that the White House refuses to negotiate and Republicans pursue their political interests through pressure. Under these circumstances, the administration claims that the House is obliged to grant the limit increase without conditions. It should be noted that the debt ceiling has been raised periodically for as long as the United States has existed as a nation.
So far, there has never been a crisis situation due to government default. Despite the differences, both parties hedged in the knowledge that in the future rivals could take revenge. Today, however, an exceptional situation seems to be taking place that brings the country closer to the first default in its history. “Time is tight. It really worries me to see where we are now,” McCarthy said.
It should be noted that the government often spends more money than it collects in taxes. That situation creates a deficit that needs to be brought into balance by raising the debt ceiling. However, this is a deal that requires legislative approval and the reigning House Republicans want to tie a spending cut compromise to unlock the ceiling.
For now, the contenders are using up the timeout represented by the Treasury funds. Yellen has been making desperate calls for months for a deal between the parties to avoid a default that could be devastating to the economy.
White House refuses to negotiate as long as cuts are on the table
Time seems to be playing in favor of the Republicans, who say they are open to negotiate. However, one of their conditions, as already mentioned, is that the government commits to cut spending in areas such as Medicare and Social Security. For the Biden administration, agreeing to negotiate means that the cuts will be taken out of the discussion. Consequently, they hope that this stalemate will end with the Republicans approving the increase in debt without touching the programs.
The White House laments that the GOP makes the debt issue an issue only when there are Democratic presidents in office. They point out that conservatives passed numerous debt limit increases during Donald Trump’s presidency. While doing this, they also lowered taxes on the wealthy and authorized new spending.
It should be noted that two months ago President Joe Biden and Kevin McCarthy met to discuss the debt issue. Based on the current climate, it is safe to assume that they did not reach an agreement. This Tuesday, the conservative sent a letter in which he asked the president not to take the non-negotiation position. He added that he is ready to negotiate without the need to take “extreme” paths.
“It is time to abandon partisanship, roll up our sleeves and find common ground on this urgent challenge,” the Speaker of the House of Representatives stressed. For the White House, the conservatives’ position is very much akin to blackmail that holds economic stability hostage. In that direction, White House press secretary Karine Jean-Pierre expressed herself:
“It’s time for the Republicans to stop playing games, agree to pass a clean debt ceiling bill and stop threatening to wreak havoc on our economy.”
What happens if the US economy defaults?
The consequences of a U.S. default could be a nightmare for the U.S. economy and beyond. As the world’s largest economy, the shockwaves would wreak havoc on other markets closely related to the U.S. economy.
This would be tantamount to a halt in the day-to-day operations of the federal government. The result would be unprecedented volatility and contraction in financial markets and the economy as a whole. It is difficult to predict the actual consequences because this would be an unprecedented situation. According to a Moody’s report in 2022, a default on Treasury bonds would cause a nosedive into a scenario similar to that of the Great Depression.
Thus, a default would cause the Gross Domestic Product to contract by -4%. The analysis house estimates that conditions for households and companies would be terrible, while 6 million people would lose their jobs.
In a letter sent by the Treasury to Congress in January, it spells out starkly what would happen in a default situation. “Social Security and Medicare benefits, military pay and interest on the national debt, tax refunds and other payments” would stop.
Failure to reach an agreement to raise the debt ceiling would also mean the inability of the Treasury to repay money and interest to bondholders. The latter is of great importance considering that Treasury bonds are a safeguard for dozens of governments around the world. Simply put, that means that the reserves of other countries held in the trusty bonds would be at risk.
A desperate option
The options to avoid catastrophe are few if the increase of the debt ceiling is not taken into account, that is to say, if they do not reach an agreement. At that stage, one of the least desirable, but at the same time decisive, options to avoid default would come into play: the creation of a $1 trillion currency. Investor Times recently wrote a paper on this possibility and the consequences it could have for the economy.
The creation of this platinum currency is not a new proposal and the most recent attempt was during Barack Obama’s administration in 2010. At that time there was a pitched battle in Congress and the administration of the day threatened to take this shortcut. Naturally, the reaction of the Republicans was hostile, but in the end it was agreed to increase the debt ceiling.
The dynamics of this is simple, the Treasury mints the currency and gives it to the Federal Reserve. The central bank then issues the corresponding money to cover government spending. While this would solve an operational issue, the medium and long-term results could be unfortunate. For example, such an injection of liquidity would cause a spike in inflation that would scuttle the Fed’s efforts to lower prices.
Both the Fed and the Treasury are opposed to the proposal and are therefore pushing for an agreement to raise the debt ceiling. However, between default and this scenario, it seems that there are no other options than the lesser evil.
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