President Joe Biden and the leader of the House of Representatives, the Republican Kevin McCarthy, stroked a deal yesterday on the budgets of the United States that would allow in time to pass the indispensable increase in the debt ceiling and prevent the country from entering a suspension of payments or default. A disagreement could cause a recession of planetary effects, or, in the words of Treasury Secretary Janet Yellen, “an economic and financial catastrophe.”
The debt limit will be exhausted, according to Yellen, around June 5. Superpower laws require an agreement from Congress to modify or suspend that ceiling and continue paying the bills. But Republicans have taken the binding pact hostage for their purposes of a spending cut that threatens the Biden administration. Without the scissors they demand, they refuse to vote in favor of the debt increase.
On Thursday night the negotiating teams of Biden and McCarthy began to caress an agreement that would provide for an increase in the debt limit by four trillion dollars; a sum sufficient to cover commitments until after the 2024 election, as the president wants. In return, Biden would accept two-year budget cuts that would affect domestic government programs. There would be a reduction in funds for the Internal Revenue Service – the tax agency of the United States – as the Republicans want. But this would not be enough for the ultra and Trumpist sector of the conservative side, who intend to extend the discount to the social and green economy areas.
An agreement between the negotiators would not guarantee its approval in the Chambers, given the reluctance of the ultras; especially after Donald Trump defended a few days ago allowing the default if Biden does not face “massive cuts” to stop spending “like a drunken sailor”. The more progressive faction of the Democrats, on the other hand, refuses to touch social issues.
What is the debt ceiling?
The debt ceiling is the amount of money the US government can borrow to pay its bills. These obligations include Social Security and Medicare benefits, tax refunds, military salaries, and interest payments on the outstanding national debt. The current cap is about $31.4 trillion. The country got there in January, but then the Treasury undertook accounting adjustments that would allow it to continue paying until June. The ceiling was established in 1917, while speeding up the issuance of bonds and to avoid an abuse of the resource and an excessive mismatch of the accounts. Today it is seen as an overly demanding and dangerous bond, but difficult to avoid or eliminate without costs.
What happens if it is breached?
It is not possible to predict what would happen if the roof did not rise in time, but it would not be good at all. Even if the breach were short-term, the Government would not be able to ask for more money and, therefore, would have to cut spending by around 25%, according to experts. The national economy would shrink by almost 1% and the unemployment rate would rise from 3.4% to 5%, leaving 1.5 million people out of work. The nation’s credit rating would go down and the US would go into recession. But if it didn’t last, it would be like a liquidity crisis. In contrast, if the disagreement were prolonged, the stock market would plunge by 20% to 45%.
Who would be affected in the first place
With no money to pay its bills, the Treasury will most likely prioritize debt payments to bondholders. This would put other recipients of federal funds in the queue, affecting tens of millions of households who would not receive timely benefits such as Social Security, Medicare and Medicaid, as well as nutrition, veterans and housing assistance . The Executive could freeze the salaries of military personnel. And if the crisis lasted for months, unemployment would climb five points, which would mean that more than eight million Americans would lose their jobs, according to the White House.
Why a financial crisis
To borrow money, the U.S. Treasury issues securities, such as bonds, which it must then pay back with interest. Once the debt limit is reached, the Treasury would be unable to issue any more securities, which would stop a key flow of money to the federal government and put an essential component of the financial system on hold. If this were to happen, “shock waves would be sent through global financial marketsâ€. Credit markets around the world would “freeze” and stock markets “crash,” according to the White House Council of Economic Advisers. Also, since investors generally view these bonds and the US dollar as safe havens, default would create an incredible loss of faith in the country and its system. Once rating agencies downgrade the U.S.’s top credit rating, investors would demand much higher interest rates on bonds to compensate for the additional risk. Borrowing costs would then rise for consumers, as both mortgage and credit card and consumer loan rates are tied to movements in the nation’s Treasury market. And companies would also pay higher interest rates.
How many times has it happened?
National default is uncharted territory because US leaders have never allowed it. Not consciously, at least, since in 1979 a technical error in accounting caused a delay in bond payments. But the mistake was rectified quickly and without much bloodshed. Apart from that, the closest it came to the abyss was in 2011, when the Republicans maintained for months a blackmail similar to that of this year. Until, just 72 hours before the limit ran out, Barack Obama reached an agreement. The incident led to the downgrade of the US debt rating by Standard
How could chaos be avoided
Leading US economists and lawyers have encouraged Biden to invoke a provision of the Constitution, the Fourteenth Amendment, which prohibits questioning the sovereign solvency: “The validity of the public debt of the United States, authorized by law, including debts incurred by to the payment of pensions and rewards for suppressing insurrections or rebellions, shall not be questioned”, the clause indicates. But the president already said weeks ago that there was no time to resort to this interpretation with a guarantee of success, since a presidential order in a similar sense would be disputed in the courts. And there would be no time to take such a momentous risk. The amendment could be invoked after an agreement to raise the current ceiling, the leader pointed out.
What to do if it happens in the end
If there was no agreement to approve the extension of the debt ceiling, some experts, including the Nobel Prize in Economics Paul Krugman, propose a couple of imaginative exits. One, the most shocking, would consist of exploiting a peculiar legal provision of 1995 that allows the Treasury to mint platinum coins of any amount it wants; for example, a billion dollars. “These coins would be deposited in the Federal Reserve and the Government could then withdraw cash from their account to continue paying their bills,” says Krugman. The other way out would be to issue perpetual bonds, which “pay interest forever, but not capital and, therefore, have no nominal value”. However, neither the Treasury nor the White House see these options as clear. The ceiling must be raised, they insist. And Biden adds: defaulting on the debt “is not on the table”. But there should be a budget agreement. And last night negotiations continued. The alternative to the pact would be such a calamity that no one in Washington would bet on disagreement.
