U.S. hits infamous debt limit. What it means and what happens next
A months-long standoff with consequences for global economy is set to unfold
A standoff over the U.S. debt ceiling has begun. It could become the country's most consequential political showdown this year, with global economic repercussions.
Treasury Secretary Janet Yellen announced Thursday that the country has hit its borrowing limit and must take extraordinary measures to delay a catastrophic and once-unfathomable U.S. debt default.
We may witness months of escalating drama.
It starts almost imperceptibly with the measures announced Thursday: the U.S. government, its ability to borrow money now limited, will delay contributions to federal employee pension plans.
It could get progressively more tense by this summer, as Washington takes increasingly desperate measures to keep up with scheduled debt payments.
That's unless the U.S. political parties reach a spending deal.
The rest of the world will have questions and it's understandable, because everyone has a stake in what comes next. After all, in this standoff, the global economy is the hostage, the Republican Party has demands and the debt ceiling is the weapon.
Here are some of those questions, answered.
What is the U.S. debt ceiling?
The U.S. Constitution gives Congress power over public finances, and Congress has always played some role in approving debt levels. It created the first modern debt ceiling in 1939.
It's just what it sounds like: a maximum level of U.S. debt. Lawmakers have had to raise it dozens of times in years past.
The U.S. owes debt to people and institutions around the world, two-thirds of them inside the U.S. and one-third abroad. They include any buyer of government-issued securities like bonds and Treasury bills, such as pension funds, mutual funds, regular investors, the U.S. Federal Reserve or other central banks — with Japan, China and the U.K. atop the list.
The country has incurred historic levels of debt: the debt ceiling was last increased two years ago to its current level, $31.4 trillion, or more than 120 per cent of U.S. GDP.
The U.S. technically hit that limit Thursday; disaster, however, can be delayed several months.
Many economists hate this system. In one economist survey, 84 per cent agreed it creates unnecessary uncertainty in the economy.
The normal way to set debt levels would be with regular spending bills, when Congress approves expenses, said Lee Roberts, who teaches public budgeting at Duke University.
"I don't think it makes any sense [this way]," Roberts said in an interview.
What happens if Congress doesn't raise the limit?
Bad things. A report by Moody's Analytics is filled with scare adjectives like "cataclysmic," "unimaginable" and "devastating."
Moody's foresees effects on par with the post-2007 financial crisis: a GDP decline of almost four per cent, nearly six million lost jobs and stock prices plunging almost one-third. An older study published by the U.S. Federal Reserve forecast similar, if slightly less dire, results as Moody's.
Those are just the short-term effects. A longer-term problem is the new risk embedded, permanently, in the world economy.
The global financial system is built upon the bedrock assumption that U.S. government-backed securities are a safe and readily available investment asset, Marc Goldwein says.
If there's a global recession caused by this, it's because that long-standing assumption is rattled, said Goldwein, an economics professor and vice-president at the Washington-based Committee for a Responsible Federal Budget.
Just look at what happened in 2011: during the last major debt-ceiling standoff, the mere talk of a potential U.S. debt default caused the first credit downgrade in American history, which wiped seven per cent from stock markets in one day.
Why are we discussing this now?
Because conditions are similar to 2011. There's a perfect political storm. Republicans have just won the House of Representatives, and they're ready for a fight with Democrats in the White House and Senate.
Remember the recent melodrama in Congress where it took more votes to pick a Speaker than at any time since the U.S. Civil War? The debt ceiling played a role in that.
Conservative holdouts made several demands upon Kevin McCarthy, one being that he drive a hard bargain before agreeing to lift the debt limit.
The conservatives want spending cuts, and see federal deficits as unsustainable. They're not alone. What we don't know is their bottom line: it's unclear how much cutting they want.
We do know, however, that McCarthy has to keep these members happy. Even a small mutiny, of just a few members, could cost him his current dream job.
What actually happens in the coming months?
Don't think of debt default as a light switch that turns on or off. It's more like a rising tide, growing steadily more dangerous.
We can actually watch that tide roll in: In daily statements, the U.S. Treasury lists its cash flow. Using that data, the Treasury's Office of Debt Management decides when to borrow money. It instructs the Bureau of the Fiscal Service to get that money by issuing securities, like Treasury bills and bonds to be repaid later.
This activity grinds to a halt with the debt limit reached.
Cash then gets tighter, and the Treasury resorts to extraordinary measures Yellen mentioned, like deferring pension contributions. This happened in 2019 and 2021, and it's about to start happening again.
There's a brief reprieve for the federal treasury in the spring. Taxpayers send cheques with their annual returns. But the tide keeps rising, and the cash keeps dwindling.
Federal contractors would be informed, at some point, of late payments.
Beyond that, you might see what happened in California in 1992 and 2009: Residents of the state got IOUs in the mail instead of normal benefit cheques.
By this point in its financial flailing, the government is doing anything it can before grasping for the ultimate panic measure: defaulting on bond payments.
The U.S. would likely face this situation by the fall — Goldwein calls this uncharted territory.
He's actually optimistic: He doesn't think we'll get there. He believes the two parties will ultimately agree on a deal, and the Republican House and Democratic Senate will agree to a new debt limit.
"I wouldn't even want to guess [what happens next]," Goldwein said. "Because I don't think even our politicians are stupid enough to get to that point."
What are politicians saying?
McCarthy, for his part, says he wants to start negotiations quickly. He points to a 2019 agreement where the ceiling was lifted in exchange for minor budget cuts.
Republicans say spending must be reined in with debt costs exploding under the triple-whammy of inflation, higher interest rates and constant deficits.
According to the Congressional Budget Office, just paying interest on the debt will cost $2.5 trillion more over the next decade than previously expected. (This, for context, is more than the U.S. spends, over one single year, on the military and old-age pensions, combined.)
The parties would have to agree on a deficit-cutting path.
Democrats argue that there's a revenue problem. Past tax cuts under Republican presidents coincided with worsening budget deficits in the Reagan, Bush and Trump eras. Republicans are focused on cuts to program spending.
The White House position at this point is: There's no negotiation. It says Congress has a basic duty to pay bills already incurred, from spending already approved by Congress.
"There will be no hostage-taking," White House spokesperson Karine Jean-Pierre said.
That position might prove unsustainable.
The basic reality is the House of Representatives has power here. It takes both chambers to raise the debt limit. Republican leaders are being told by their members, in no uncertain terms, to use their power.
And the pressure on McCarthy to fight will only grow in the coming months as conservative talk radio and TV warn against caving.
Even President Joe Biden seems to acknowledge this won't be automatic: He recently alluded to the long days he spent in 2011, including on New Year's Eve, negotiating a deal to avert that debt crisis. It took almost $1 trillion in spending cuts.
"We've always been able to work together," Biden said.
That deal, however, happened under John Boehner. The then-Republican House Speaker had to work to coax enough members to pass it.
Could McCarthy achieve the same?
In his memoir, Boehner mentions McCarthy just one time — it's related to the 2011 debt-limit battle. And it's not complimentary. He castigates McCarthy's behaviour in that crisis as weak, saying he failed in his leadership duties and scurried out of the chamber before Boehner could ask why he bailed on a budget deal.
"[That] really pissed me off," Boehner wrote.
That incident, Boehner said, contributed to him eventually bypassing McCarthy as his heir apparent for the Speaker's job; he said Paul Ryan had shown leadership qualities by standing firm and voting for a budget deal.
Well, here we are again.
This time, McCarthy's in charge. The hardliners have more control.
And some worried moderates from both parties have already begun preliminary talks about employing a rare parliamentary tactic to bypass McCarthy and force a debt-ceiling vote.
It's a longshot.
Whatever happens, Roberts of Duke University hopes there's a deal, the sooner the better: "Because the consequences are so dire you would hope they would reach a resolution."
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