President Joe Biden on 03 June signed the bill that will raise the U.S. debt limit, avoiding by two days a government default. The Bill, which was passed by the U.S. Congress despite opposition from some members of both parties, has also brought to the forefront the deep partisan divide within America. The debate has also raised questions about the debt levels in America and for spending cuts to increase the ceiling limit. While lawmakers from both sides agree that there is a need to reduce federal government spending, they disagree on how deeply to cut spending, the areas that require spending cuts and where additional revenue should be part of the formula to bridge the budget deficit. The threat of default has pushed parties to negotiate but the partisan divide is making it more and more difficult to arrive at a consensus. The current crisis was averted after tense negotiations between the Republican and Democratic Party on cuts and spending of the government’s money over the next two years. The paper highlights the importance of the U.S. debt ceiling negotiations for both the U.S. and global economy.
What is Debt Ceiling/limit?
Under the division of powers between the legislature and the executive, Article 1 Section 8 of the U.S. Constitution states that, “The Congress shall have Power To lay and collect Taxes, Duties, Imposts and Excises, to pay the Debts and provide for the common Defence and general Welfare of the United States;…To borrow Money on the credit of the United States;….”[i] This power was delegated to the U.S. Department of Treasury with the stipulation that the approval of the Congress would be needed for increasing the debt limit.
The debt ceiling or limit is the total amount of money that the U.S. government is authorized to borrow to meet its existing legal obligations, including on Social Security and Medicare benefits, military salaries, interest on national debt, tax refunds, and other payments. This allows the U.S. government to finance existing legal obligations that Congresses and the presidents have made in the past but does not allow new spending commitments.[ii] To overcome the difference between spending and available funds, the government has to borrow money to continue to finance payments that Congress has already authorised. As the U.S. hits its limit, unless Congress raises or suspends the debt limit, the federal government will lack the cash to pay all its obligations.
The debt limit was created in 1917, and it gave the Treasury Department autonomy for borrowing limit debt up to the debt ceiling without congressional approval, making it easier to finance mobilization efforts during World War I. Before that, Congress generally had to authorize the Treasury to borrow in smaller increments.[iii] The first debate on the issue was held in 1953 when President Eisenhower requested an increase in the debt limit. According to the Treasury Department, since 1960, Congress has acted 78 separate times to permanently raise, temporarily extend, or revise the definition of the debt limit – 49 times under Republican presidents and 29 times under Democratic presidents.[iv] In each of those instances, Congress took action on the debt limit before the U.S. defaulted on its obligations.
The Treasury Department can postpone a default through temporary solutions called “extraordinary measures.” These include suspending payments to some government employee savings programs, under-investing in certain government funds, and delaying auctions of securities. While the Treasury Department has used these measures in the past, including in 2011 and 2013, the Congress has, till yet never failed to raise the ceiling before the extraordinary measures have been depleted. If, however, the Congress does not act to raise the debt limit despite such emergency measures, then other measures such as reducing federal spending and/or increase taxes would need to be implemented. The U.S. President is also authorized to invoke the Fourteenth Amendment of the U.S. Constitution, which states that “the validity of the public debt of the United States… shall not be questioned….” Other measures that can be invoked include selling U.S. gold and minting platinum coins to the extent of a total amount of US$1 trillion. However, the Amendment and the other measure have largely been viewed as unsustainable and detrimental to the economy.
The Current US Debt Ceiling Crisis and Negotiations
Over the years negotiations to increase the debt ceiling have increasingly become more political with both parties taking it as an opportunity to extract concessions, take a political stand and blame the party in the White House of lack of fiscal insight. The brinkmanship over the issue has increasingly led to disruptions, including government shutdowns and the looming threat of default that will push the domestic and international economies into a crisis. For example, the tense negotiations between the Republican-led Congress and President Obama resulted in a protracted deadlock in 2011 which was resolved two days before the Treasury Department estimated it would no longer have funds. The standoff triggered the most volatile week for U.S. stocks since the 2008 financial crisis, and the credit rating agencies such as S&P Global downgraded the U.S.’ creditworthiness for the first and only time ever which in turn impacted the value of U.S. treasury bonds and the U.S. dollar.
The current crisis and the long negotiations had led to similar fears. In exchange for the support for raising the debt ceiling, Republicans demanded federal spending cuts to limits as set in 2022 and restrictions on future spending for a decade, with rise in defence spending being an exception. They also sought other concessions, including stiffer work requirements for recipients of government cash aid, food stamps and the Medicaid healthcare program. They pointed that the current national debt of US$ 31 trillion is unsustainable and demanded budget cuts to the tune of US$4.5 trillion which included less spending on key initiatives of the Biden Administration such as renewable energy. In the negotiations the Democrats sought spending to be held at current 2023 levels and less stringent rules on work requirements for people who receive government aid.
After months of negotiations President Biden and Speaker of the House Congressman Kevin McCarthy (R, Cali) announced that the two parties had come to an agreement. The agreement has led to a two-year suspension of the US$ 31 trillion debt ceiling, which allows the government the latitude to keep borrowing money and pay its bills on time.[v]
As per the negotiated agreement, in exchange for suspending the limit, the Biden Administration has agreed to limits on the growth of federal discretionary spending over the next two years and cuts in non-discretionary spending which includes domestic law enforcement, forest management, scientific research, etc. As per the Republicans’ demand, unused COVID funds will be returned to the Treasury, which the Congressional Budget Office estimates to be about US$ 30 billion. Some of that money will be repurposed to boost nondefense discretionary spending. President Biden has also agreed to some new work requirements for certain recipients of food stamps and the Temporary Aid for Needy Families program but the Democrats have been able to ensure that Medicaid requirements remain untouched.[vi] Both sides agreed to modest efforts meant to accelerate the permitting of some energy projects. The Bill officially ends President Biden’s freeze on student loan repayments and restricts his ability to reinstate such a moratorium. Defence spending would increase to US$ 886 billion in 2024, which amounts to a 3 percent increase this year, which was requested by President Biden.
The US Debt Ceiling and its Economic Impact
An actual breach of the U.S. debt ceiling would cause critical damage to the U.S. economy. Analysis by Council of Economic Advisors (CEA)[vii] and external researchers point that if the U.S. government were to default on its obligations—whether to creditors, contractors, or citizens—the economy would quickly shift into reverse, with the depth of the losses dependent on how long the breach lasted. According to Moody’s, even a short debt limit breach could lead to a decline in real GDP, nearly 2 million job loss and an increase in the unemployment rate to nearly 5 per cent from its current level of 3.5 per cent. The ability of households and businesses, especially small businesses, to borrow would also be compromised. The risks endangered by the default would cause interest rates to increase, including those on the financial instruments that households and businesses use—Treasury bonds, mortgages, and credit card interest rates.[viii] This would lead to a recession within the U.S.
The crisis in the U.S. also has implication for the global economy. Economists have argued that a decreased demand for U.S. treasury securities would weaken the dollar’s role in the global economy. The creditworthiness of U.S. treasury securities has long bolstered demand for U.S. dollars, contributing to their value and status as the world’s reserve currency and a lack of confidence in the U.S. economy’s strength as a result of default or uncertainty would lead investors to sell the U.S. treasury securities which would likely weaken the dollar. This in turn would have a domino effect as nearly half the world’s foreign currency reserves is held in U.S dollars and most global transactions are valued in U.S. dollars. Heavily indebted low-income countries struggle to make interest payments on their sovereign debts, a weaker dollar could make debts denominated in other currencies relatively more expensive and threaten to tip some emerging economies into debt or political crises.[ix] The financial panic would cause credit markets to freeze investments and the stock markets too will plunge. Both the U.S. and the world economy will face a recession.
Conclusion
The U.S. has been able to avoid a default on the federal government’s debt. Nonetheless, the tense negotiations and the opposition of the Freedom Caucus in the House of Representatives and some members of the Democratic Party have raised the need to find alternative solutions to the protracted negotiations. While the U.S. can remove debt ceiling it would require Congressional approval which is unlikely to emerge. The ceiling is also seen as a means to check government spending and borrowing.
Although the U.S. debt has technically hit the debt ceiling limit many times over the past 12 years, in each of these cases, the Treasury Department has undertaken a set of “extraordinary measures” so that the debt limit did not actually bind, and Congress raised or suspended the limit before these measures ran out. However, in the recent past the negotiations have become more partisan and prolonged. The debt ceiling crisis has raised questions on the financial power of the U.S and the dollar and it is clear that the consequences for the American and global economy could have been dire. The U.S. would have to look for solutions for the future that ensure that it does not bring the country to the brink of a default and in turn, shock international economic stability.
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*Dr. Stuti Banerjee, Senior Research Fellow, Indian Council of World Affairs, New Delhi.
The views expressed are personal.
Endnotes
[i] US National Archives, “The Constitution of the United States: A Transcription,” National Achieves, https://www.archives.gov/founding-docs/constitution-transcript (Accessed on May 01, 2023).
[ii] U.S. Department of Treasury, “Debt Limit,” U.S. Department of Treasury, https://home.treasury.gov/policy-issues/financial-markets-financial-institutions-and-fiscal-service/debt-limit (Accessed on May 01, 2023).
[iii] Nik Poli and Olivia B. Waxman. “What to Know About the History of the Debt Ceiling,” The Time Magazine, May 18, 2022, https://time.com/6281003/debt-ceiling-history/ (Accessed on June 02, 2023).
[iv] Op.Cit 2, U.S. Department of Treasury.
[v] The debt ceiling is US$31.4 trillion as of June 2023.
[vi] Jim Tankersley and Alan Rappeport. “New Details in Debt Limit Deal: Where $136 Billion in Cuts Will Come From,” The New York Times, June 02, 2023, https://www.nytimes.com/2023/05/29/us/politics/debt-ceiling-agreement.html (Accessed on June 04, 2023).
[vii] The Council of Economic Advisers, an agency within the Executive Office of the President, is charged with providing the President objective economic advice on the formulation of both domestic and international economic policy.
[viii] “The Potential Economic Impacts of Various Debt Ceiling Scenarios,” The White House, May 03, 2023, https://www.whitehouse.gov/cea/written-materials/2023/05/03/debt-ceiling-scenarios/ (Accessed on June 04, 2023).
[ix] Noah Berman. “What happens when the U.S. hits Debt Ceiling?,” The Council on Foreign Relations, May 25, 2023, https://www.cfr.org/backgrounder/what-happens-when-us-hits-its-debt-ceiling (Accessed on June 02, 2023).