Amid fears of a crisis, the US begins the debt ceiling battle
With the United States (US) hitting its debt ceiling limit on Thursday, America has entered a period of a gruelling political battle over a debate on the issue, with the White House warning that Republican obstructionism risks push the country towards an economic “catastrophe” and Republicans placing the responsibility of an agreement on Democrats
With the United States (US) hitting its debt ceiling limit on Thursday, America has entered a period of a gruelling political battle over a debate on the issue, with the White House warning that Republican obstructionism risks push the country towards an economic “catastrophe” and Republicans placing the responsibility of an agreement on Democrats.
In a letter last week, Treasury secretary Janet Yellen notified the Congress that the US will hit its debt ceiling limit of $31.4 trillion on January 19. The administration will have to resort to “extraordinary measures” after the deadline. While it can continue to do so till the summer, unless the Congress either suspends or raises the limit, the US then risks defaulting on its debt obligations and faces the prospect of a credit rating downgrade.
A distinction is important here. The debt ceiling is not about how much the executive can spend — the Congress separately authorises spending. But since the US has a large deficit, the executive borrows to meet its expenditure by issuing bonds and other debt instruments. As the US Government Accountability Office (GAO), the key audit institution in the country, puts it, “The debt limit does not restrict Congress’s ability to enact spending and revenue legislation that affects the level of debt or otherwise constrains fiscal policy; it restricts Treasury’s authority to borrow to finance the decisions already enacted by Congress and the President.”
The battle begins
On Tuesday, White House press secretary Karine Jean-Pierre told reporters that President Joe Biden is clear that the Congress must deal with the debt ceiling and do so “without conditions”.
“But Congressional Republicans are threatening to hold the nation’s full faith and credit, a mandate of the Constitution, hostage to their demands to cut Social Security, to cut Medicare and to cut Medicaid. Brinksmanship that threatens the global economy.” Failing to deal with debt ceiling, the White House warned, will lead to “economic catastrophe”.
In turn, the House Speaker Kevin McCarthy, has made it clear that the House will not raise or suspend the ceiling unless it is accompanied by drastic spending cuts — a key Republican theme.
He said this week, “We are six months away, approximately, and what I would like to do is I would like to sit down with all the leaders and especially the president and start having discussions. Who wants to put the nation through some type of threat at the last minute with the debt ceiling? Nobody wants to do that.” McCarthy got elected on his 15th attempt after a set of far-Right legislators had, among other measures, demanded that he hold the line on not raising the debt ceiling.
The economics and evolution of debt ceiling
Explaining the concept of the debt ceiling, Arvind Subramanian — former chief economic advisor to the Government of India, a senior fellow at Brown University’s Watson Institute for International and Public Affairs, and an authority on global economic trends — told HT, “According to the US Constitution, the Congress must authorise borrowing. The debt ceiling was instituted in the early 20th century so that the US Treasury did not have to go each time to get Congressional authorisation to pay its bills (if you run a fiscal deficit as the US does, you need to borrow to pay your bills). You set a limit and within that you can borrow.”
In 1917, to muster up financial support for the Allied cause in the First World War, the US began issuing what were called the liberty bonds to citizens. Through the Second Liberty Bond Act, the Congress imposed a limit on the number of bonds that could be issued. Note the context that Subramanian highlighted — till then, the Congress had to authorise each debt or had to specifically allow Treasury to issue certain debt instruments for specified purposes. By placing a limit, the Congress actually was granting flexibility to the executive to borrow and make payments.
In 1939, the Public Debt Act then aggregated all federal debts. The ceiling imposed on the extent to which the Treasury can to borrow to meet its obligations has kept getting amended over the years — for instance, the Congress increased the limit from $65 billion in 1941 to $275 billion in 1945 to $985 billion in 1981 to $4.6 trillion in 1996 to over $30 trillion now. In total, since the Second World War, the debt ceiling limit has got amended over 80 times.
In recent decades, as political polarisation in the US has intensified, debt ceiling has become an instrument in partisan battles — especially when Democrats control the administration and Republicans control the Congress. Subramanian said, “As deficits became big and as political polarisation took over beginning with Newt Gingrich and others in the 1990s, it became a political tool….Republicans try and use this to reduce spending but that is often a cover to bargain with, and even bully and humiliate the administration.”
Raising or suspending the ceiling limit requires a simple majority in both the House and the Senate; so having control over a single chamber is enough to pin down the administration. The most visible example of the debt ceiling crisis was in 2011, when the Barack Obama administration clashed with the Republican Congress — a case study that merits attention given the similarities with the situation today.
The 2011 crisis
Back then, the Far-Right Republicans had just established their presence in American politics as a result of the Tea Party movement; today, Far-Right Republicans, as a part of the freedom caucus, control the direction of the party in the House. Back then, the Treasury had to resort to “extraordinary measures” to stave off the possibility of a default; today, it will have to begin doing the same till the Congress relaxes the ceiling. Back then, Republicans believed that Democrats would be held politically culpable for their failure to manage the economy and they could pressure the White House into making concessions; today, a similar political calculation exists on the Right.
In a report on the 2011 to the Congress, the GAO traced the evolution of the battle. In January 2011, the Treasury secretary told the Congress that the debt limit would be reached between mid-March and mid-May.
In early May, Treasury, to stave off a crisis, began taking a set of “extraordinary measures” — these included, among other measures, suspending the issuance of new state and local government securities; suspending new investments in the civil service retirement and disability trust fund and redeeming certain investments held by the same fund earlier than normal; suspending new investments to the postal benefits fund; stopping everyday investments from the holdings of the G-fund, a retirement fund for federal employees.
Eventually, Democrats and Republicans struck a deal at the end of July, two days before US would exhaust its options. The Congress agreed to increase the ceiling by $900 billion, but in return, Obama agreed to a cut in spending by $917 billion over the following decade. But by then, American economic and political fault lines had played out starkly. The stock markets had tumbled, S&P downgraded the US credit rating for the first time in its history, and GAO estimated that the crisis had raised American borrowing costs by $1.3 billion.
Subramanian points to the structural flaw in the logic of the debt ceiling. “What is odd is that the Congress independently approves spending and tax bills which automatically determines borrowing. So, the debt ceiling is an additional, over-kill lever. Denmark does have a debt limit but it sets it so high that breaching it is not an issue.” In a 2021 blog, the GAO too highlighted the weaknesses of the approach. “Delays in raising the debt ceiling can disrupt financial markets, increase U.S. borrowing costs, and threaten the full faith and credit of the United States.”
What was once meant to give the administration leeway has emerged as a key constraint on its ability to borrow and repay its debts — and, in 2022, may well invite the most serious financial crisis that the US has confronted in years.
The 2022 crisis and implications
Even as the contours of the battle are similar, the biggest difference between 2011 and 2022 is that the Republican Right is an even stronger force in the Congress — and McCarthy is completely dependent on it. To make it to Speaker, he agreed to a provision where a single member of the House can move a motion to remove him from office. This is expected to tie his hands as negotiations over the debt ceiling begin.
The other difference is that Joe Biden, Vice President during the 2011 crisis, emboldened by his victory in the midterms, does not appear to be in a mood to make any concessions on public spending — which has been a key instrument in the electoral success of Democrats. Biden’s stance is reflected in the White House’s demand for an unconditional rise or suspension of the debt ceiling limit.
Even as the US battles it out, the world will be watching. Explaining the implications of a default if the Congress doesn’t act on the ceiling, Subramanian said, “If the US breaches the limit, then financial markets panic because trust in the single most trusted borrower in the world — Uncle Sam — is jeopardised. And literally every interest rate in every market in the world is priced off US government bonds (the debt). So, if this market is rattled, the risk is of all global markets being rattled.” He added that the crisis also puts a spotlight on America’s domestic political polarisation and its influence in undermining US credit and global standing. “You can’t be a superpower if you can’t pay your bills domestically because there is so much infighting.”