Historical precedent suggests negotiations to raise the debt ceiling are likely to go right to the wire, but Republicans and Democrats will ultimately reach a compromise
By V Thiagarajan
Hyderabad: The debt ceiling drama has reached a fever pitch in recent weeks. There are dire predictions of global financial chaos if the US Congress fails to agree on a deal to raise what is known as the debt ceiling.
The debt limit caps the total amount of allowable outstanding US federal debt. The US hit that limit — $31.4 trillion — on January 19, 2023, but Treasury has been undertaking a set of “extraordinary measures” so that the debt limit does not get exceeded.
Tracing History
From 1789 to 1917, debt ceiling laws did not exist. Specifying the national debt level was introduced only in 1917 when cumbersome wartime budget exigencies proved incompatible with infrequent Congressional sessions. In 1917, the US needed to borrow a lot of money for World War. To simplify that process, Congress shifted to a new system in which it permitted Treasury to borrow up to a specified amount of money and then seek raising of that limit.
Broadly speaking, in the modern era, debt ceilings serve no purpose, and thus, are not in vogue in most countries. The lone exception is Denmark where it has never been a political issue. The only other country to ever adopt debt ceilings, Australia, experimented with them for five years before abandoning them a decade ago.
Current Crisis
The timing of when Treasury will not have enough cash to meet its obligations — the so-called ‘X-date’— is uncertain because it depends on the inflows of federal tax payments.
Estimates of the X-date range from early June to early fall. The range is so wide because the delay in the tax filing deadline for those affected by storms in California makes the pace and amounts of federal tax particularly uncertain this year. That uncertainty underlines the urgency around this issue.
US Treasury Secretary Janet Yellen, however, said that June 5 appears to be the deadline by which the country will run out of funding to continue business as usual. It was earlier estimated to be June 1.
It was on December 16, 2021, that Congress last raised the debt ceiling. After much hand-wringing and political infighting, lawmakers eventually agreed to a $2.5-trillion extension, raising the limit to $31.385 trillion. Treasury is currently stuck with a more familiar and pressing obstacle — raising the debt ceiling and avoiding default. Ironically, the debt ceiling prevents Treasury from drawing more funding from the private financial market.
Without the ability to raise new debt, since late September 2022, the Treasury General Account has been drawing down to pay for debt service on government bonds among the myriad other outlays like federal employee salaries with all available cash on hand.
A drawdown in Treasury General Account is positive for financial system liquidity. When it draws down, it pushes liquidity back into the system that it had previously removed. They’re now getting quite low compared to their desired target (absent a debt ceiling issue) of $500 billion.
On the other hand, the Fed has been pursuing its Quantitative tightening programme shrinking its balance sheet by either selling Treasuries or Mortgage-backed securities or by letting them mature and removing them from its cash balances. This removes liquidity from financial markets.
Hence, since September 2022, the overall domestic liquidity has been rather flat, as the Federal Reserve and the Treasury Department effectively offset each other. Risk assets have generally followed suit.
It has become increasingly clear that, even in the best-case scenario, the Treasury’s General Account will be extremely low (<$50 billion) in the first half of June if the debt ceiling is not raised. Put another way, a fifty-fifty chance of an early June default in the absence of a debt ceiling increase is still very concerning and highlights the clear risk of hitting the X-date in early June.
As of May 17, the US Treasury roughly had $68 billion in cash on hand and another $92 billion of untapped extraordinary measures. Taken together, it had just $160 billion of additional borrowing capacity remaining under the debt ceiling.
For context, the average daily non-debt cash outflow from the Treasury General Account this year has been about $30 billion, and daily withdrawals of more than $50 billion are not uncommon. Unless Congress raises or suspends the debt limit, the federal government will lack the cash to pay all its obligations and prevent default. While the Treasury General Account and extraordinary measure balances continue to dwindle, lawmakers are attempting to negotiate a deal that would increase or suspend the debt.
Politics of the Crisis
A handful of times in recent years, most notably in 2011, Congress used the debt ceiling to pressure a presidential administration to either extract a bargain or for narrative gain, rather than to readily raise it.
Similar to the 2011 debt ceiling impasse, the government is divided along partisan lines, with Democrats controlling the presidency and the Senate, and Republicans controlling the House. All three branches of the government need to pass any legislation that would raise the debt ceiling, meaning an agreement between the two parties must be struck.
Debt ceiling is also a tool that can be used to extract concessions from the other party, even though it’s technically only about whether the government will pay previously-authorised spending obligations and honour its debt. Often, when politicians oppose raising the debt ceiling, they do so within the narrative of fiscal constraint, but like many things these days that is mostly political theatre.
Historical precedent suggests negotiations to raise the debt ceiling are likely to go right to the wire, but that Republicans and Democrats will ultimately reach a compromise to prevent the US government from defaulting on its debt obligations.
According to data going back to 1960 by the US Treasury, Congress has raised or suspended the debt ceiling 78 times, including 29 times under Democratic presidents and 49 times under Republican presidents.
House Republicans have said they will not raise the limit if President Joe Biden and lawmakers do not agree to future spending cuts. The Biden administration has made clear that it is not going to allow Republicans to repeal the entire clean energy title of their signature legislative Act from the most recent Congress. But some elements of the Limit, Save, Grow Act are still on the table.
Republicans have a strong incentive to forge a compromise with Democrats. That said, one difference with 2011 is that the Republican House majority is relatively slim, which could make it more difficult for House Speaker McCarthy to garner sufficient support for an agreement. The risk is that there could be Left-wing opposition to an eventual deal that would further complicate the already tenuous vote math on both sides of the aisle.
For a deal to be reached and turned into law before early June, a breakthrough in the negotiations will need to occur this week. So far, negotiations between the two sides have not yielded a deal. This is not to say no progress has been made.
Probable outcomes
Highly likely
There is a high probability of a bipartisan compromise that both raises the debt ceiling and imposes some modest spending cap besides clawing back about $30 billion in unused Covid-19 aid. Broadly, there are two most likely outcomes:
Less Likely
Treasury may have the legal authority to mint and issue a “collectible” trillion-dollar platinum coin and deposit it at the Federal Reserve in exchange for cash to pay the government’s bills. However, Yellen has noted that the Fed, reluctant to intervene in a partisan political dispute, might not accept the deposit.
There is a minuscule probability that the 14th Amendment to the Constitution — which says that “the validity of the public debt of the United States … shall not be questioned”— would allow Treasury to ignore the debt limit and indeed requires it to meet all obligations.
But these actions would certainly be viewed as circumventing the law that establishes the debt ceiling.
Impact
The substance of a debt ceiling deal remains just as fluid as its prospects. It is important to keep in mind that any major changes in the fiscal policy outlook could have a material impact on the broader economic outlook. The fiscal austerity that flowed from the 2011 debt ceiling showdown resulted in a significant drag on economic growth in the years that followed.
Oxford Economics also figures an agreement before the deadline could negatively impact the economy but for a different reason. If Biden agrees to $2.4 trillion in spending cuts — slightly more than half the amount demanded by Republicans — that would turn a mild recession into a severe one.
In the End
A happy resolution to the drama may require the markets to play the role of “disciplinarian”, pressuring Congress to take appropriate action to avoid another credit-rating downgrade or an unprecedented US debt-default scenario. As of this writing, however, the probability of a rancorous and unfruitful political process, perhaps leading to an undesirable outcome, remains high.
A technical default — one that involves the government missing coupon payments and, therefore, triggering credit default swaps — is highly unlikely. A scenario of a temporary default is reasonably possible, given how polarised politics has become and how large the debt and deficits are now.
(The author is an Independent Market Expert)
The X-date