The United States is yet in another debt ceiling standoff, in just over 10 years, which has the potential to bring with it worse eventualities than before. The last political confrontation over raising of the debt threshold was in 2011 and it led to the first downgrade in the history of the US. The sovereign credit rating descended from AAA (Excellent) to AA+ (Outstanding). The US stock market lost a considerable portion of its value, at the time, with the Dow Jones Industrial Average losing 5.5% of its value, exactly two days after the downgrade, on 8 August 2011. This was the 6th lowest dip of the stock market index, in US history. Today, there is an ongoing impasse between the two main political parties over the debt ceiling, once more, with the Republicans advocating for spending cuts into the future, as a condition to approve the debt cap.
With US national debt at $31.4 trillion and a GDP of $25.4 trillion, their debt to GDP ratio stands at 124% and has been increasing rapidly in recent years. Republicans refer to the growing deficit as a “ticking time bomb”. On the other hand, Democrats are arguing that Republican-proposed cuts in healthcare and education will impact American lives and instead of looking at the growing deficit as a set of numbers, they are converting these numbers into human lives and human experiences. Ultimately, the difference in spending approaches into the future, are at the centre of this latest debt stalemate, which has persisted for several months.
The historical background to the US debt limit legislation stem from a section in their constitution which gives Congress the exclusive right to authorise government borrowing, under Article 1, Section 8 of the U.S constitution. In the former ages, Congress would approve or decline every form of debt, on a case-by-case basis. However from 1917, the practice transformed to a system where they would set an aggregate limit for the nation’s debt limit and then review it when it was nearing the summit.
The practice may have created an advantage of keeping government alert towards its borrowing excesses, with the goal of encouraging responsible government expenditure.
However, it is increasingly becoming an issue that whenever there is a difference between the head of state and the holders of majority in Congress, debt ceiling legislation is leveraged to bring in political demands of the majority party in Congress. In this case, the Republican House Speaker, Kevin McCarthy, has intimated his’ party’s willingness to approve the debt ceiling but after the White House accepts spending cuts which will curtail Treasury spending on healthcare, education and climate change projects. The deal being sought by the Republican party will see the Treasury budget being reduced to 2022 levels and have a modest 1% annual growth for the next decade. The Republicans argue that it is imperative to contain the growing U.S budget deficit. Growing and persistent Treasury deficits are feeding into troublesome U.S inflation, which peaked at 6% (CPI), in February, this year and will make it harder for the nation to repay its sovereign debt in the future.
It is also vital to look into what should arise next, in the case that the debt ceiling limit is reached, before its increase is approved by Congress. In such a development, Treasury cannot borrow more funds which are needed to support government expenditure. There is an interesting scenario though, whereby the legislation does not stop Treasury expenditure but rather, it stops new borrowing. This means is that government can continue to engage in contracts as per normal budget assignments for the year but all payments to service providers will not be able to be fulfilled legally, as the law would have suspended accrual of new debt, which is indispensable for settling current obligations. Treasury payments will only cover what can be fulfilled by cash receipts such as tax collections. In other words, this means that the US government will not only default on interest payments to holders of Treasury assets such as bonds, but it will also default on payments to various service providers, unless they halt some parts of government operations, owing to the need to fulfill all payment obligations to suppliers.
A default in payment to bond holders, will lead to further downgrades on sovereign risk or credit rating. This will raise the cost of borrowing even higher for Treasury as a lower rating will lead to expensive credit. Higher borrowing costs will translate to reduced fiscal space as the Treasury will be able to commit sourced funds to more limited avenues. A larger portion of government revenue will need to be assigned towards interest payments, compared to previous times as well. This chain will lead to overall higher interest rates in the US market, including the banking sector. The cycle of events that may unfold from these developments include sustained inflation, depreciation of the dollar, reduced standards or living as both households and firms will need to commit more to their private debt repayments, owing to relatively higher interest rates. In all this, a “doomsday” scenario where government will need to suspend some of its operations due to an inability to borrow, is probably one of the most unfavorable possible outcomes.
It is reasonable to expect Treasury to use its resources to avert such negative eventualities. In this case, Treasury may address the borrowing gap by using what are called “extraordinary measures”. In between a delay and an approval of instating the new ceiling, measures that can be used include, re-directing funds originally meant for government employee pensions. This means pension deductions will not be invested into their usual destination such as the “Thrift savings plan” and the “Gfund” but used as cash to settle government payment obligations. Above that, any government investments that can be redeemed before their maturity will also be called in and assigned towards settling government obligations. Additionally, government owned resources such as gold may be dissolved towards meeting the funding gap. Ultimately, these “extraordinary measures” will not be sufficient to meet all government commitments for long. They may suffice for a few months, as, the larger the spending needs of government, the shorter they will last. To put this into perspective, the new debt ceiling that is being negotiated by Congress, is expected to last only 11 months into the future and will need another review at that time.
In the meantime, it is vital to state that the longer that the haggling continues, the greater the challenge presented to the economy. The ongoing impasse, in itself, can lead to a credit rating downgrade. In the case of an actual default to pay bond holders, then the country is in an unprecedented debt crisis. As Janet Yellen, the current Treasury secretary has pronounced, failure to raise the debt ceiling is potentially catastrophic for the US. The nation finds itself in uncharted territory as it is not only besieged by legislation gridlocks but also recent bank collapses, reduction in holdings of global US dollar foreign exchange reserves, etc. A marked and unwelcome latest development in the US markets, is the news that money supply in the domestic market, contracted, for the first time in 90 years. A number of notable analysts are stating that the contraction foretells a slow down in economic activity, which may in effect be a depression. With current efforts by the Federal Reserve Bank to curtail persistent inflation, this imputes the possibility of stagflation in the US domestic market. The developments in the U.S market will contrast unfavorably with current events in China, their latest rival and competitor for global influence. The robust growth, benign inflation, and growing global adaptation to the Yuan in global payments systems, is setting China to be the newest entry into what is set to become a multipolar world.
Some analysts and scholars argue that the US should remove the requirement for debt ceiling approval, from the constitution. As stated earlier, complications which may arise owing to Congressional debate over the ceiling, are unfavorable. Other opponents of the debt ceiling legislation, also point out that there are clauses in the constitution which make government borrowing superior to Congressional approval. For example, the 14th amendment of the US constitution states that, “The validity of the public debt of the U.S shall not be questioned…” These quarters argue that this portion of the constitution means that it is illegal for the country to default on its debt. Thus all organs of government, including Congress, are obliged to work towards settling of all US government debts, without restrictions. Others maintain that since Congress is responsible for approving each year’s government budget, the approval of a debt ceiling represents a largely repetitive process. Thus, for so long as budgets are approved by the House-of-representatives, there is no need to do an additional procedure to approve a mere debt ceiling which simply pertains to a figure, rather than a detailed paper outlining the direction, value and nature of government spending as contained within the budget.
What countries like Zimbabwe may learn from these occurrences in the US, is that there is a perennial need for main political parties to complement each other for the overall good of the nation. When there is an impasse which can translate to costs for the nation, it should be resolved at the earliest opportunity. Bickering does not work for the ultimate good. Another lesson to be gleaned from the scenario is that debt to GDP ratio should be managed so as to maintain fiscal space and a healthy domestic financial market. There are yet countries with a higher debt to GDP than the US, such as Japan, but a review shows that they can afford to sustain such levels as they are notable net exporters and their currencies are not as overvalued as the dollar, for instance. Nevertheless, it appears that a lower debt to GDP ratio is a more sustainable option, overally.
Kevin Tutani is a political economy analyst. He can be reached at tutanikevin@gmail.com
Disclaimer:
The views expressed in this article are those of the writer and do nto necessarily represent those of the Zimbabwe Broadcasting Corporation.
