The US government is facing a looming possibility of running out of funds in the coming weeks unless it authorizes additional borrowing. This raises the question of how we arrived at this critical juncture. Recently, US President Joe Biden held a crucial meeting with Republican House Speaker Kevin McCarthy to revive negotiations on the budget, which carries significant implications. The potential consequences of failing to reach an agreement on raising the debt ceiling, also referred to as the borrowing limit, are dire, with predictions of global financial turmoil and the risk of a US debt default. To learn more continue reading the latest edition of our traders digest
US Debt Ceiling: Risks of Default and Economic Consequences The debt ceiling, also known as the debt limit, is a legal restriction on the total amount of money that the government can borrow to cover its expenses. This encompasses various crucial obligations such as federal employee salaries, military funding, Social Security, Medicare, interest on the national debt, and tax refunds. Periodically, the US Congress votes to raise or suspend the debt ceiling to enable additional borrowing. Currently set at approximately $31.4 trillion, the debt limit was surpassed in January, prompting the Treasury Department to employ «extraordinary measures» to provide temporary funding while a solution was sought. Typically, raising the debt limit is a routine procedure for Congress, but this time, agreement on the terms has proven elusive. Treasury Secretary Janet Yellen has issued a warning that without an increase in borrowing, the US government will face a shortfall in meeting its financial obligations as early as June 1. This unprecedented situation raises concerns about significant economic repercussions. Failure to raise the debt ceiling would result in the government being unable to pay federal and military salaries, halt Social Security payments relied upon by millions of pensioners, and jeopardize organizations reliant on government funds.
Moreover, a default on interest payments on the national debt would have severe consequences, potentially causing disruptions in the financial system where over $500 billion of US debt is traded daily. In the event of a prolonged stalemate, Moody’s Analytics predicts a nearly 20% decline in stock prices, an economic contraction of more than 4%, and the loss of over seven million jobs. The implications of a US debt default and the ensuing economic damage make reaching a resolution imperative for the stability of both national and global financial markets. In the long run, if investors perceive US debt as increasingly risky, they will demand higher interest rates when lending money to the US government. As government borrowing significantly influences interest rates across the economy, this would have a ripple effect, leading to higher borrowing costs for individuals seeking loans for homes, cars, and other purposes. There have been discussions regarding the possibility of the government prioritizing interest payments to prevent a debt default. However, politically, it is challenging to justify a situation where financial institutions, pension funds, and foreign investors receive their payments while retirees and other groups are left unpaid.