Debt ceiling: the clock is ticking

The clock is ticking since the US hit its debt limit in January. The US Treasury may run out of cash by June 1. The 2011 rating downgrade due to a debt ceiling crisis provides a possible template for market reaction going forward. Other factors were at play then, but there could be lessons to be learned from the summer of 2011.

What’s the debt ceiling?

The debt ceiling is an oddity. There does not have to be a debt limit. The debt ceiling is a cap on US government borrowing affecting the ability of the federal government to pay existing bills. The US government may approve a budget in deficit but be deprived by Congress of the authority to borrow.

There are ‘ideas’ to get around the debt limit. President Joe Biden could invoke the 14^th Amendment of the US Constitution, which guarantees the validity of the public debt, as a ‘solution’, basically making the cap unconstitutional. The US Treasury could mint $1 trillion in platinum coins and place them with the Fed to keep spending. But none of the above have been seriously considered.

In 2011, Standard & Poor’s downgraded the US government’s rating. Then-President Barack Obama, agreed to more than $2 trillion in spending cuts over a decade to end the crisis. Still, two years hence, the cap was suspended for the first time.

The US hit the current federal debt limit of $31.4 trillion in mid-January. Since then, the US Treasury has been using extraordinary measures (for instance withholding contributions to a federal employee retirement fund) to delay the day of reckoning. That moment, the ‘X-date’, when extraordinary measures will be exhausted, could arrive by early June. The actual default date could be days or weeks later.

Upon default of the US government, many domestic and foreign institutions holding Treasury securities and American households including Social Security recipients, members of the military, or families with children would be affected. There could be a partial shutdown of government agencies. Failure to pay bondholders would also have cascading effects, with credit rating agencies downgrading Treasury debt, raising costs, and the availability of borrowing in all sectors of the US economy.

The debt limit must be raised. Leaders from both sides of the aisle recognize it. Since 1960, Congress has acted 78 separate times to permanently raise, temporarily extend or revise the definition of the debt limit. But, over time, it has become a recurrent political weapon. House Republicans led by Speaker Kevin McCarthy want to pair an increase in the debt ceiling with cuts in federal outlays. On April 26th, 2023, House Republicans passed a bill that would raise the debt ceiling by $1.5 trillion in exchange for $4.8 trillion in budget deficit cuts over 10 years. The divided Congress means that the bill has no chance of making it through the Senate where Democrats hold a majority. A deal must be struck.

Playing with fire as X-date looms large

The X-date is believed to fall around June 1. The Treasury general account (TGA) is published weekly by the Fed. The TGA is running on empty with less than $200 billion left. For reference, government spending may fetch $500-600 billion a month.

The federal budget outturn in April (a big month in terms of tax collection) was disappointing with a smaller-than-expected surplus. The bigger shortfall so far in 2023 compared with last year appears partly due to lower capital gain tax receipts after the 2022 market rout.