Economy
US debt ceiling: Is there a global crisis brewing?
Summary
There is a limit set to how much the US government can borrow to meet its legal obligations, which include paying interest on its debt and paying military salaries, tax refunds, and social security, etc. The debt ceiling is currently set at $31.381 trillion
On 1 May, treasury secretary Janet Yellen sent a letter to the US Congress saying that on 1 June the government is likely to run out of money. With the government currently breaching its debt ceiling, the situation has become parlous. Mint explains what’s happening:
What is the US debt ceiling?
There is a limit set to how much the US government can borrow to meet its legal obligations, which include paying interest on its debt and paying military salaries, tax refunds, and social security, etc. The debt ceiling is currently set at $31.381 trillion. This limit was breached on 19 January. Since then, the Treasury department (finance ministry) has taken extraordinary measures to curb some government investments in order to be able to continue paying bills. The government has some ready cash at any point of time. But this cash and the extraordinary measures are expected to run out by 1 June.
Why has debt ceiling been breached?
Around the world, almost all governments spend more than they earn. This difference is known as the fiscal deficit and is financed through taking on debt. The US government has been running massive fiscal deficits post 2008, when the financial crisis broke out. It ran a deficit of more than a trillion dollars every year from 2009 to 2012. In 2020 and 2021, it ran eye-watering deficits of $3.13 trillion and $2.77 trillion. The government spent a lot of money to counter the negative economic impact of the covid pandemic. These deficits were financed by taking on debt, which is why the ceiling was breached.
By how much has the US government debt gone up?
The total government debt has jumped from $9.49 trillion in June 2008 to around $31.4 trillion currently. Of course, the US economy has grown in size as well. The total US government debt to gross domestic product ratio was 63.85% in June 2008. It is now greater than 120%. GDP is the measure of the size of any economy. So, the US debt has almost doubled in 15 years.
So, what’s the way out of this?
The US Congress can permanently raise the debt ceiling or suspend it temporarily or allow the government to go past the debt ceiling without raising it. To increase the debt ceiling a majority vote is required in both Houses of the US Congress. The Republicans want cuts in government spending on things like electric vehicle incentives. The problem is that US politics has become increasingly polarised, which has led to negotiations between Republicans and the ruling Democrats going right down to the wire.
What are the likely implications of this?
If no consensus is reached before 1 June, the US government will end up defaulting on its legal obligations, leading to huge job losses in the US. Global financial markets could be roiled. As per Mark Zandi, chief economist of Moody’s Analytics, this could lead to a 2008 financial crisis-kind of situation “characterized by spiking interest rates and plunging equity prices". Given this, it is highly likely that the Republicans and Democrats will find a way out before 1 June.
