Historical precedent suggests that talks to raise the debt ceiling are likely to run to the last minute, but that Republicans and Democrats will eventually reach a compromise
Published Date – Sunday, 5/28/23 at 12:30pm
by V Thiagarajan
Hyderabad: The debt ceiling drama has reached fever pitch in recent weeks. If the U.S. Congress can’t reach an agreement to raise the so-called debt ceiling, dire predictions of global financial chaos loom.
The debt limit limits the total amount of outstanding U.S. federal debt allowed. The U.S. hit the $31.4 trillion ceiling on Jan. 19, 2023, but the Treasury Department has been taking a series of “extraordinary measures” to keep from exceeding the debt limit.
trace history
From 1789 to 1917, debt ceiling laws did not exist. A specific level of national debt was not introduced until 1917, when cumbersome wartime budgetary emergencies proved incompatible with infrequent Congressional sessions. In 1917, the United States needed to borrow a lot of money for the world war. To simplify the process, Congress turned to a new system in which it allowed the Treasury Department to borrow a certain amount of money and then seek to raise that limit.
- Denmark is the only country with a popular debt ceiling, but it was never a political issue
Broadly speaking, in modern times, the debt ceiling doesn’t mean anything, so it’s not popular in most countries. The only exception is Denmark, which has never been a political issue. Australia is the only country to have adopted a debt ceiling, experimenting with it for five years before abandoning it a decade ago.
current crisis
When the Treasury will run out of cash to meet its obligations — the so-called “X date” — is uncertain because it depends on the inflow of federal tax revenue.
The estimated range for X date is from early June to early fall. The range is so wide because delays in tax filing deadlines for those affected by the storm in California have made the pace and amount of federal tax payments particularly uncertain this year. This uncertainty underscores the urgency of the issue.
However, U.S. Treasury Secretary Janet Yellen said June 5 appeared to be the deadline by which the country would run out of funds to continue business as usual. An earlier estimate was June 1.
The last time Congress raised the debt ceiling was on December 16, 2021. After much tension and political infighting, lawmakers finally agreed to a $2.5 trillion extension, raising the cap to $31.385 trillion. The Treasury now faces a more familiar and pressing hurdle — raising the debt ceiling and avoiding default. Ironically, the debt ceiling prevented the Treasury from raising more money from private financial markets.
Without the ability to raise new debt, since late September 2022, the Treasury General Account has been using all the available cash on hand to withdraw federal employee salaries and myriad other expenditures to cover debt service charges on government bonds.
A reduction in the Treasury’s general account is good for financial system liquidity. When it drops, it pushes liquidity back into the system it removed earlier. Compared to the expected target of $500 billion (without the debt ceiling issue), they are now quite low.
- Australia was the only country to adopt a debt ceiling, experimenting with it for five years before abandoning it a decade ago
The Fed, on the other hand, has been pursuing its quantitative tightening program, shrinking its balance sheet by selling or letting them mature and removing U.S. Treasuries or mortgage-backed securities from its cash balance. This removes liquidity from financial markets.
Thus, since September 2022, domestic liquidity has been flat overall as the Fed and Treasury effectively offset each other. Risk assets generally followed suit.
It is increasingly clear that, even under a best-case scenario, the Treasury’s general account will be extremely low (<$50bn) in the first half of June if the debt ceiling is not raised. In other words, without raising the debt ceiling, the possibility of an early June default remains very concerning and highlights the obvious risk of hitting date X in early June.
As of May 17, the US Treasury Department had about $68 billion in cash on hand and $92 billion in unused extraordinary measures. All told, it has just $160 billion of additional borrowing capacity left under the debt ceiling.
For context, the average daily non-debt cash outflow from the US Treasury’s general account this year is about $30 billion, and daily withdrawals of more than $50 billion are not uncommon. Unless Congress raises or suspends the debt ceiling, the federal government will be short of cash to pay all of its obligations and prevent default. While the Treasury’s general account and extraordinary measures balances continue to decline, lawmakers are trying to negotiate a deal to increase or suspend the debt.
politics of crisis
Congress has used the debt ceiling several times in recent years, particularly in 2011, to pressure the White House to either bargain or for narrative gain rather than raise the debt ceiling lightly.
Similar to the 2011 debt-ceiling standoff, the administration is divided along partisan lines, with Democrats controlling the president and Senate and Republicans controlling the House of Representatives. All three branches of government would need to pass any legislation to raise the debt ceiling, meaning a deal would have to be reached between the two parties.
The debt ceiling is also a tool that can be used to force concessions from the other side, although technically it is only about whether the government will pay its previously authorized spending obligations and meet its debts. Usually, when politicians oppose raising the debt ceiling, they do so against a backdrop of austerity, but like so many things these days, it’s mostly political drama.
Historical precedent suggests that talks to raise the debt ceiling are likely to run to the last minute, but that Republicans and Democrats will eventually reach a compromise to prevent the U.S. government from defaulting.
According to US Treasury data since 1960, Congress has raised or suspended the debt ceiling 78 times, 29 times under Democratic presidencies and 49 times under Republican presidencies.
House Republicans have said they will not raise the cap if President Biden and lawmakers do not agree to future spending cuts. The Biden administration has made it clear that it will not allow Republicans to repeal the entire clean energy title of its signature legislative bill from the most recent Congress. But some elements of the Limit, Save, and Grow Act are still on the table.
- The debt limit limits the total amount of outstanding U.S. federal debt allowed.The U.S. reached this ceiling on January 19th – $31.4 trillion
Republicans have strong incentives to reach a compromise with Democrats. Still, one difference from 2011 is the relatively slim Republican majority in the House, which could make it harder for House Speaker McCarthy to gather enough support to strike a deal. The risk is that there could be opposition from the left against a final deal, further complicating the already fragile voting math on both sides of the aisle.
A breakthrough in negotiations is needed this week in order to reach a deal and turn it into law by early June. So far, negotiations between the two sides have not resulted in an agreement. That’s not to say progress hasn’t been made.
possible outcome
Probably
A bipartisan compromise is likely to raise the debt ceiling and impose some modest spending caps, in addition to recouping about $30 billion in unspent Covid-19 aid. Broadly speaking, there are two most likely outcomes:
- Last minute deals late May/early June involve some spending caps.
- Suspension of the debt ceiling to allow more time for negotiations, possibly until the end of the fiscal year on Sept. for the first time since late 2018-early 2019).
Not too possible
The Treasury may have the legal authority to mint and issue “collectible” trillion-dollar platinum coins and deposit them with the Federal Reserve in exchange for cash to pay government bills. However, Yellen noted that the Fed, unwilling to intervene in partisan political disputes, may not accept the deposit.
- Since 1960, Congress has raised or suspended the debt ceiling 78 times, 29 under Democratic presidencies and 49 under Republican presidencies
The 14th Amendment to the Constitution — which states that “the validity of the public debt of the United States . . .
But those actions would certainly be seen as circumventing the laws that set the debt ceiling.
Influence
The substance of the debt-ceiling deal is as volatile as its prospects. It is important to remember that any significant change in the outlook for fiscal policy could have a significant impact on the broader economic outlook. Fiscal austerity resulting from the 2011 debt-ceiling showdown severely weighed on growth in subsequent years.
Oxford Economics also believes that reaching a deal before the deadline could have a negative impact on the economy, but for different reasons. If Biden agrees to $2.4 trillion in spending cuts — a little more than half of what Republicans have demanded — it would turn a mild recession into a deep one.
in the end
A happy resolution may require the market to act as the “discipline” and force Congress to take appropriate action to avoid another credit downgrade or an unprecedented US debt default. However, at the time of writing, the chances of a hostile and fruitless political process (which could lead to undesirable outcomes) remain high.
A technical default — one that involves the government failing to pay a coupon and thus triggering a credit default swap — is highly unlikely. Given the polarized politics and the current size of the debt and deficit, a temporary default scenario makes sense.
(The author is an independent market expert)
X dating
- X-date comes when the government no longer has enough financial buffers to pay all the bills
- The latest calculation by Treasury Secretary Janet Yellen is that the U.S. could default as early as June 5 without a deal to raise legal borrowing limits to support bill payments
- Shai Akabas of the Bipartisan Policy Center helped coin the term “X-Date” in 2011 with future Fed Chairman Jerome Powell
- “We define it as the day when the federal government fails to meet all of its obligations, meaning that if policymakers don’t act by X date, default will happen the next day,” Akabas said
