Debt ceiling forcing US into emergency cuts to avoid financial catastrophe

Debt ceiling forcing US into emergency cuts to avoid financial catastrophe

  • Natalie Sherman
  • From BBC News in New York

January 20, 2023

US Treasury Department

Credit, Getty Images

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The risk of the US hitting the debt ceiling is the highest in years

The US government has reached the legal borrowing limit. The Treasury Department is taking steps to avoid a default that could be devastating to the US economy and impact the rest of the world.

Hitting the debt ceiling means the government can’t borrow more money unless Congress agrees to suspend or change the debt limit, which currently stands at nearly $31.4 trillion.

That usually happens.

Since 1960, politicians have raised, extended or revised the debt ceiling 78 times three of them in the last six months alone.

But since Republicans took control of the House of Representatives and demanded spending cuts, tensions have risen in Congress. Some believe lawmakers will delay any debt resolution this time, pushing the US into a willful default for the first time in its history.

What would happen in this scenario?

What will the US do now?

For most people, the effects should hardly be noticeable at least for the first few months.

The US Treasury can manage the situation by taking steps to avoid going over the debt limit. In the past, this included measures such as suspending investments in health and pension funds for federal employees. Subsequently, these investments are compensated to maintain the level due.

In a January 19 letter, Treasury Secretary Janet Yellen announced a similar “debt issuance moratorium” for the Civil Service Pension and Disability Fund (CSRDF) until June 5 and the suspension of payments to the Postal Service Retired Health Benefit Fund ( PSRHBF).

“Under the law, the CSRDF and PSRHBF will be supplemented once the debt limit is raised or suspended,” the letter reads. “Retirees and federal employees will not be affected by these measures.”

But delays also have important consequences.

The stalemate on issuance in 2011 prompted credit agency S&P to downgrade the country’s rating—unusual in the US at the time.

Government analysts estimated that delays this year caused the US Treasury’s borrowing costs to rise by at least $1.3 billion as uncertainty demanded higher interest rates from investors.

Analysts are already assuming that the debate on the topic this year will make the financial markets nervous.

Treasury Secretary Janet Yellen estimated that special measures could help the US buy time until at least June when the government ran out of money to pay its bills.

Analysts see an economic catastrophe in this scenario.

Some believe that the authorities must do everything possible to avoid defaults. That means finding ways to pay interest while leaving other obligations unpaid, such as B. Defense contractor payments; Social Security checks received by retirees across the country and salaries of government employees, including military personnel.

Even something as simple as weather forecasts can be affected, as many meteorologists rely on data from the governmentfunded National Weather Service.

A default could undermine the country’s reliability and shake global financial markets, where US debt is rife and traditionally viewed as low risk.

Credit, Portal

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President Joe Biden rejected requests for spending cuts in exchange for a debt ceiling hike

The dollar would weaken and borrowing costs would soar—first for the government, but ultimately for the general public in the form of higher interest rates on home loans and credit card debt.

Reaching that point would be unprecedented for the US and would do widespread damage to consumer confidence and the economy, which is already in a precarious state.

“Failure to meet government obligations would irreparably damage the US economy, the livelihoods of all Americans and global financial stability,” Yellen recently warned.

Why has this become an increasing problem?

The debt limit was first introduced in 1917 to give the government flexibility to raise money during World War I. In theory, this gives Congress a way to retain some control over Executive Branch spending.

But the battles over the debt ceiling have become increasingly turbulent, with greater political polarization. US debt skyrocketed, nearly doubling in a decade.

This is partly due to high government spending during the financial crisis and pandemic but it also reflects the fact that the country has run a budget deficit (more spent than taken in) every year since 2001.

The debt ceiling has always been a means of political leverage.

The 2011 debt limit dispute was resolved when thenPresident Barack Obama agreed to more than $900 billion worth of spending cuts demanded by Republicans and the debt limit was raised by a similar amount.

Some Republicans are now pushing spending cuts again — but this time Democrats reject the idea.

Brazil

The US government debt ceiling differs from the spending ceiling in Brazil. In the American case, the law places limits on how much money the government can borrow. In the Brazilian case, the limit is imposed on the budget for the year.

The spending cap passed by Congress in 2017 during the government of Michel Temer was the target of criticism from the two presidential candidates Luiz Inácio Lula da Silva and Jair Bolsonaro in the last elections.

In 2022, the Bolsonaro government even considered replacing the spending cap with something akin to a debt cap, but the idea never materialized.

Lula’s new economy minister, Fernando Haddad, has already promised that Brazil will have a “new fiscal framework” by April this year, but it’s not clear what his plan will be.