The US debt clock in Manhattan is ticking steadily, reaching $31 trillion, and this relentless rise poses a risk to the global economy, as it is now approaching the US debt ceiling.
The debt ceiling is the amount that Congress has allowed the US government to borrow in order to meet its basic obligations, from providing medical insurance to paying military salaries.
The current ceiling for total debt is $31.4 trillion (117% of GDP), and America is heading towards it fast.
Janet Yellen, Treasury Secretary, warned on May 1 that the United States is threatened to default on its debts as of the beginning of June, amid a dispute between Republicans and Democrats over raising the borrowing ceiling in America… So what does that mean?
A deep recession and eroding confidence in the global financial system… What does it mean for US debt to reach its highest ceiling?
A report by the British Economist magazine says that at this stage the United States will either face a default on sovereignty or swing cuts in government spending.
Either outcome could be devastating for global markets.
a default would undermine confidence in the world’s most important financial system; Big budget cuts could lead to a deep recession.
Even if Congress can raise the debt ceiling before anything too serious happens, courting disaster is a warning about America’s declining financial health and the difficulty of restoring it.
The debt ceiling is a political innovation devoid of any fundamental economic meaning, as no other country binds its hands in such a crude way, says The Economist.
However, this means that you need a political solution, which cannot be taken for granted in the current stalemate between Democrats and Republicans.
Investors are starting to worry amid uncertainty about whether Democrats and Republicans will be able to work together.
Yields on treasury bills due in early June rose by a percentage point after Ms Yellen’s warning, a sign that few are willing to hold onto government paper that could come under fire.
A bill proposed by Kevin McCarthy, the Republican speaker of the House of Representatives, would push the cap back to 2024, while cutting trillions of dollars in spending over the next decade and laying out plans to combat climate change.
The bill passed the Republican-controlled House of Representatives on April 27, but it wasn’t a start for the Democrats, which means that it won’t authorize Senate approval.
Separately, a maneuver by House Democrats, known as the “petition void” — a vague mechanism that enables 218 lawmakers to pass bills that the speaker refuses to consider — could allow a small cap increase, but it would take five Republicans to disagree.
With McCarthy and siding with the Democrats, which few will do before an election year.
However, the bet is that American politicians will somehow find a way out of the impasse, as they have in the past.
US President Joe Biden has called leaders from both parties to a meeting at the White House, on May 9, where negotiations are likely to begin, something Biden had hoped to avoid, preferring a “clean” bill to raise the debt ceiling.
If and when this happens, the “gymnastics” of the American budget will fade from view.
Yet that would be a shame, says The Economist, because the country’s finances are on increasingly precarious ground.
The primary measure of vulnerability is not primarily America’s level of debt, but rather its ballooning fiscal deficit.
Over the past half century, America’s federal deficit has averaged about 3.5% of GDP per year.
In its latest update in February, the Congressional Budget Office (CBO), a nonpartisan body, projected that America’s deficit would average 6.1% over the next decade.
This is probably an underestimate, as the CBO does not include recessions in its forecasts.
Even without the amount of spending that was unleashed when COVID-19 hit the world.
Recessions lead to higher deficits as tax revenues fall and automatic stabilizers like unemployment insurance rise.
Like many analysts, the US central bank chief is also struggling to put a price tag on the broad new industrial policy of the Biden administration.
It was initially thought that spending on subsidies for electric cars, renewable energy and others would cost about $400 billion over the next decade.
But since so much of the subsidy comes in the form of unlimited tax credits, Goldman Sachs thinks the bill could be closer to $1.2 trillion.
What’s more, the CBO only provides forecasts based on current laws. As the political landscape changes, so do the laws.
In 2017, Donald Trump went through a series of tax cuts, which are set to expire in 2025.
In making his predictions, the director of the Office of Communications must, by statute, assume that they will end as scheduled.
Yet few politicians want to raise taxes.
Biden is also vying to implement a student loan forgiveness plan that would increase the deficit.
When only part of these variables are factored in — higher spending on industrial policy plus continued Trump tax cuts — the deficit will average 7% over the next decade, reaching nearly 8% by the early 2000s.
The current century, which means disaster for America.
America’s debt will double to 250% of GDP by mid-century.
Year after year, this expanded borrowing will lead to much larger debt.
On the central bank’s trend line, federal debt will nearly double to nearly 250% of GDP by mid-century.
Long before that time, New York’s debt clock, which currently stands at 14 digits, will need to add 15 as the national debt crosses the $100 trillion line!
There is no iron-clad threshold beyond which a deficit or debt can be a problem.
Instead, it can be seen as eroding, threatening progressively more damage to the US and global economy.
When the debt is large to begin with, the high interest rates that have come into play over the past year are difficult to fully absorb.
The main reason the central bank has recently revised its deficit estimate into the 2020s is the government’s higher financing costs.
The US economy will suffer from financial weakness and poverty.
At the same time, the government’s need to attract savings from investors at home and abroad could lead to increased pressure on interest rates.
The risk that investors, especially foreigners, decide to divert money elsewhere would increase America’s fiscal vulnerability, which in turn would limit the country’s ability to deploy stimulus in the face of a cyclical slowdown, according to The Economist.
The result will be an economy that is poorer and more volatile than it would have been in a world in which deficits remain in check.
How to avoid this unfortunate fate?
Direct economic prescription.
Even before the interest rate shock, it was easy to expect deficits to increase over time.
The bulk of federal spending is mandatory expenditures on Social Security, health insurance, and the like, which are mandated by laws and aren’t subject to the vagaries of the annual budgeting process.
These expenditures will swell as the population ages, and annual spending on income support for the elderly will be the same as spending on education, the environment, national defense, science, and transportation by 2033.
The US government estimates that the trust funds that help fund both Social Security and health programs will be insolvent by the early 2030s.
At that point, the United States will face a fundamental choice between cutting benefits and raising taxes.
A similar calculation will be applied to all other aspects of the federal budget: a combination of cutting expenditures and raising revenues is the only way to prevent a crippling rise in the federal deficit.
In the end, for all their concerns about the financial outlook, the former CBO directors are also unanimous in the view that failing to raise the debt ceiling now, thus opening the door to default, is a terrible idea.
The mere threat of doing so threatens more financial damage to the government, by increasing borrowing costs and burdening American economic growth.
Therefore, America requires, at this crucial moment, a serious political debate, and a bipartisan agreement to put its budget on sounder foundations, to get out of this unimaginable disaster.
It’s known where its consequences will reach.