The current drama over the raising of the US debt ceiling is not new and unprecedented; it has happened in 2011 and again in 2013. The debt ceiling has been raised many more times- including thrice during the Trump Presidency, without any fuss, threats of deliberate default or drama. But, with the US Republican Party seeming more and more like an out-of-control truck the current control over the House of Representatives gives them a loud megaphone to create the drama they seem to crave.
Janet Yellen, the US Treasury Secretary, and former Head of the Federal Reserve has flagged off a possible reach and breach of the self-imposed debt ceiling by as early as 1st June- a little more than 3 weeks away at this point. She is making personal calls to heads of industry to update them of the possible consequences of a default- possibly in the hope that they will talk to Republican Congressmen. The current limit is set at US$ 31.4 trillion and requires the nod from the US Congress to raise it and allow the debt to rise. It should be noted here that this is not approval or sanction for fresh spending- in other words, this is not a budgeting exercise. This is merely to approve the payment of the debt already accrued and falling due. They are merely rubber stamping the payments incurred by Bills passed by the House of Representatives themselves. Essentially, this isn’t about setting a credit card limit for yourself but about paying off the amounts you’ve already spent on it.
The Republican Party- and it is entirely only the Republican Part that is behind this, is trying to use the right of refusal of raising the limit to force deep cuts to future spending plans in social welfare and education- in line with their priorities. This is a form of blackmail given that they were quite happy to see large increases in debt during a Republican Presidency- especially after they themselves had approved of a massive tax cut for the wealthy. The last few standoffs happened in 2011 and 2013 under an Obama Presidency with Republican House control. They clearly perceive this as a legitimate tactic even though it has no logical or ethical basis. So, it should be made clear here that the requested spending cuts they are negotiating are not being done in good faith and is essentially a form of financial terrorism.
This is no exaggeration. The financial implications of a US debt default will be potentially catastrophic for the globe. The US has made itself the epicentre of all financial markets through the use of the US Dollar. Moreover, countries maintain half their FX reserves in US sovereign debt. If the US refuses to honour its sovereign US debt, then the cascading effects on the global economy cannot even be calculated at this point. This is what is at stake in this standoff.
Obviously, there is still time for a solution but- at this moment, both sides are not backing down from their positions. From a technical perspective then: any default will not happen at once on the outstanding debt but slowly as the debt or interest payments fall due. This is critical since it gives the Fed some window to play out the crisis until a solution is agreed to. The Federal Reserve is considering a few options from its history of managing financial crises in the last two decades and the most likely ones are:
- The central bank can accept defaulted securities as collateral from holders for their discounting window/ repos as long as the default does not reflect an inability to meet US obligations. The Fed has been doing this since 2011.
- They can even buy/ sell these defaulted debts at face value rather than at their impaired value- as they did during the recent Silicon Valley Bank crisis.
- They could even do outright purchases of defaulted securities and increase their balance sheet size (quantitative easing) or, swap defaulted securities for ones expected to be repaid (and make themselves into a ‘bad bank’ of impaired debt).
These options are open, along with the now standard Fed policy if using repo/ reverse repo agreements to ensure liquidity- they could add amounts to repos to add liquidity to the system (up to USD 1 trillion per day), or they could suspend their current programme of Quantitative Tightening (and even reverse it, as suggested in the third point above).
The likelihood of Fed action is almost guaranteedif a political solution fails even though the Fed Chairman Jerome Powell is known to personally disfavour some of the suggested possible Fed interventions since they raise questions about their independence from the Treasury Department. Powell is known to have remarked that he found the last possibilities (outright purchase or swapping good for bad loans) as ‘loathsome’.
From a political angle, President Biden could invoke the 14th Amendment of the US Constitution (although this is contentious) to avert a breach. Constitutional scholars are split on this issue and so it could lead to legal challenges that would go to the US Supreme Court. Essentially, the invocation of the 14th Amendment would hinge on the line that the validity of public debts “shall not be questioned” and that President Biden, by ignoring the ceiling would be upholding the Constitution over government legislation. In the last comments Biden made on this- over the weekend, he stated that he hadn’t ‘got to that point yet’ about invoking the 14th Amendment. He did, however, summon the heads of both major parties in the House for meetings to discuss the possibility of coming to a solution.
This is a crisis created by a political/ bureaucratic technicality that threatens the stability of the global financial order. It is an unnecessary piece of drama that could have damaging consequences not just for the US economy but for the world. Whatever the Fed and the US Treasury can do in the event that the ceiling is breached will only be applying a band aid to a gaping wound. The US political leaders instigating this crisis had better learn that quickly.