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Close Look: May 2023

one year ago

CLOSE LOOK
The US debt ceiling - what’s the big story?

Financial markets have traded in a tight range over recent weeks. Market professionals put this down to the stand-off over the US debt ceiling, which has prompted ratings agency Fitch to put the US on watch for a possible downgrade of its AAA rating. But what is this ceiling? And why is it talked of as a potential volatility event? We lift the lid on the finances of the US government.

In broad terms, the US government finances the economy via a combination of tax receipts and borrowings. Spending can at times exceed the money coming in, meaning the level of borrowing increases. But the $31.4 trillion limit on the government’s debt was hit back in January. As chance would have it, the level of tax receipts this spring did not match up to forecasts, so that the government is now looking to fund the shortfall by issuing more debt. 

Any raising of the debt limit or ceiling requires the approval of both houses of Congress. This is where it became tricky. President Joe Biden and House Speaker Kevin McCarthy have agreed a compromise, which would suspend the debt ceiling to January 2025.  The ruling Democratic party are keen to raise the ceiling, but opposition Republicans have only agreed as the Democrats reined in their spending plans, including on green investment. Why does this matter? Because on a certain day, known as X-Date, the money would simply run out.

US Treasury Secretary Janet Yellen had predicted that X-Date would be reached in early June. This would have triggered the US government to freeze its least pressing payments, such as pension contributions. Eventually, the government could have been forced to cancel interest payments on its debt. Such a default should be viewed as an extreme step, despite the claims of former president Donald Trump, as it would have triggered a volatility event of some scale. 

Various alternative solutions were put forward, including the creation of a platinum coin with a value of $1 trillion that could be used to pay for the government’s expenses. Some claim that the 14th Amendment of the US Constitution allows the president to ignore the debt ceiling altogether. It was widely believed that a deal would be reached, and the debt ceiling raised, after a period of high stakes brinkmanship, as was the outcome to similar crises in 2011 and 2013. And in the meantime, the prospect of a US debt default is being kicked down the road for another two years.

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