The US economy hit its debt limit of 31.4 trillion USD in January, and the Treasury Department had to take extraordinary measures to cover the cost of government operations. If the debt ceiling is not raised, the federal government is at risk of defaulting on the national debt as soon as next month.
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Public debt crisis threatens US economy, impacts global economy
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Fierce confrontation
Created by Congress in 1917, the debt limit, or ceiling, sets the maximum amount of outstanding federal debt the US government can incur. Every time the US government's debt reaches the public debt ceiling, a rise in the ceiling is voted on in Congress. Any change to the debt ceiling requires a majority approval by both chambers of Congress.
This year, Congress once again fell into a familiar squabable over raising the ceiling. This is not the first time the US has faced the risk of default. Since 1960, Congress has raised the debt ceiling 78 times, most of the time without a fuss. In recent years, however, both parties have used the issue as leverage to advance their political agendas.
Republicans want concessions in exchange for their vote to raise the ceiling. Last week the US House of Representatives, dominated by Republicans, passed a proposal to raise the national debt limit 1.47 trillion USD in the next fiscal year, but it must be accompanied by the "Limit, Save, and Grow Act 2023" which would limit the growth of spending to 1% annually.
This condition is vehemently opposed by President Joe Biden and the Democrats because it would mean ending the program to forgive student loan debt, which is a key Biden policy. It would also mean cutting back social welfare programs like Medicaid and parts of Biden’s Inflation Reduction Act (IRA) such as clean energy tax incentives.
To avoid a default, on May 9 President Biden met with House Speaker Kevin McCarthy, Republican members, House Minority Leader Hakeem Jeffries, Senate Majority Leader Chuck Schumer and Senate Republican Leader Mitch McConnell. That discussion was fruitless. The President and the Democrats called on Congress to lift the debt ceiling without conditions. House Speaker McCarthy said the House will not pass any deal if the government does not cut spending.
President Biden was supposed to meet Democrat and Republican leaders of both chambers on Friday to discuss raising the ceiling, but the meeting was postponed and replaced with a discussion between congressional staffers and administration officials.
US economy’s recession and its negative impact on the global economy
According to economists, in the case of a long-term default, more than 8 million people in the US will lose their jobs, the US GDP will drop 6.1 percentage points and the stock market will lose nearly half of its value. For a short-term default, the economy would lose half a million jobs, unemployment would increase 0.3 %, and the GDP would shrink 0.6 percentage points.
A US debt default would hasten economic recession after repeated interest rate hikes by the US Federal Reserve to curb inflation have increased borrowing costs for households and businesses and slowed bank lending.
A US debt default would wreak havoc on the global financial system, which is at a sensitive time of post-COVID instability and recent bank failures. The US is the world's largest economy and more than half of the world's foreign currency reserves are in US dollars. A fluctuation in the US economy could prompt investors to sell US Treasury bonds and weaken the dollar. A sudden drop in the value of the dollar would cause poor and developing economies with large public debts pay more. Debts in other foreign currencies would also increase, triggering more debt crises.
For investors and countries with long-term US government bonds, if the US government defaults, these bonds will seriously depreciate, and the asset value of the holders of US Treasury bonds will also fall.
President Biden says raising the US public debt ceiling is the most important issue now, more important than attending the upcoming G7 Summit in Japan.