In the United States, negotiations have been underway for weeks to increase the so-called “debt ceiling”, i.e. the amount of money that the state can borrow on the markets and which must be periodically authorized by Congress. These are very important negotiations because if an agreement is not reached within a few days, the United States risks defaulting on its debt: that is, it risks no longer being able to repay its debts, and this could have very serious consequences for the American and world economy.
Raising the debt ceiling is a periodic issue in US policy, which under normal conditions does not create major problems. In recent months, however, the Republican Party, which controls the House, has decided to transform what would be a normal control function of Congress into a political weapon: in exchange for raising the debt ceiling, it has asked President Joe Biden harsh conditions, such as huge cuts in social spending. Some Republican officials, including former President Donald Trump, have hinted that they are ready to send the country into default if their terms are not accepted.
Negotiations are still ongoing and the chances of reaching an agreement are discreet: President Biden announced on Wednesday that he will reduce the duration of his trip to Asia (where he will participate in the G7) precisely to participate in the negotiations. The days to agree, however, are few: according to estimates by the Treasury Department, the United States could reach the debt ceiling by the beginning of June. It means that the US government, if the debt ceiling is not raised soon, will run out of money to pay its employees, the military, health care programs, finance public works and meet its financial obligations to investors. If these obligations are not fulfilled, the United States will default for the first time in its history.
It is not the first time that the United States risks default because an agreement on the debt ceiling cannot be found: it had already happened in 2011, when Barack Obama was president and, once again, the Republican Party controlled Congress. Even then there were negotiations due to the demands of the Republicans, but a last minute deal was made and default was avoided.
The debt ceiling
Like many countries in the world, and practically all Western countries, the American state operates in deficit: this means that state revenues (mainly taxes) are less than expenditure, and therefore to finance its activity, the United States has need to get into debt, i.e. to issue government bonds which are then bought and traded on international markets. This practice is common and standard: Italy too periodically issues government bonds to finance its activity, i.e. to pay public salaries, support education, health care, the army, infrastructure and so on.
Unlike Italy, however, the US Constitution says that the state must receive Congressional authorization to issue debt. Until 1917, one Congressional vote was needed for each individual loan. Since 1917 it has been decided for a more agile practice: setting a maximum debt ceiling and allowing the government to move as it sees fit within that limit.
Whenever the debt ceiling is reached due to inflation or an increase in public spending, it is necessary for Congress to approve its increase, otherwise the country risks finding itself without money to spend even on current activities.
This situation is somewhat contradictory, because the US Congress already approves every single increase in public spending every time a tax cut or an infrastructure plan is voted for, for example. But then it has to hold a separate vote on the debt ceiling to decide whether or not to borrow the money it needs to pay for the very expenses it had previously approved. Ezra Klein, a New York Times reporter, called the debt ceiling “the dumbest aspect” of American legislation.
Other analysts and economists are less critical and believe that this double scrutiny by Congress is useful for keeping the US public debt under control, and that the debt ceiling negotiations are an opportunity for political forces to discuss how to optimize the public spending.
Debt ceiling negotiations have always taken place, and the opposition party has often used the ceiling as a tool to win concessions from the incumbent government. But in the last decade, coinciding with a strong polarization of American politics, on two occasions the Republican Party decided to use its control of Congress to make the debt ceiling a devastating political weapon: it happened in 2011 and it is happening. Now. In exchange for their consent to the increase in the debt ceiling, today the Republicans are asking for public spending cuts of around 5,000 billion dollars, an enormous amount that would risk compromising social and infrastructural plans.
For months, Joe Biden’s administration had rejected any negotiations, saying that the debt ceiling had to be raised without conditions. Then, as the deadline approached, Biden found himself forced to negotiate with Kevin McCarthy, the Republican Speaker of the House. Making an agreement will be difficult, also because McCarthy is a very weak speaker and at the mercy of the most radical current in the party, which wants to take advantage of the debt ceiling to seriously damage the Biden administration. It is likely that in the event of a compromise, Biden will be forced to grant a large cut in social spending.
The alternative, however, would be worse. If the United States fails to raise the debt ceiling, the US state will no longer be able to pay public salaries and all other expenses. It would also fail to meet its debt obligations, which would mean that the US would default on its debt.
When a state issues debt in the form of government bonds or other obligations, it must periodically pay creditors the interest on these bonds. If unable to pay, the state defaults automatically. This would be very serious for any state because a country in default, i.e. a country that does not pay its debts, is a country that international investors no longer trust, and that finds it much more difficult to finance itself again on the markets or is forced to do so at very high interest.
This problem is even more serious for the United States, which is considered the most stable economy in the world, on which much of the overall stability of the global economy depends: US government bonds are considered one of the safest financial products in the world , and are probably the most popular financial product ever. If the United States defaults, and if the world’s most popular financial product turns out to be no longer so secure, many analysts fear that it could create large and risky situations of uncertainty in the financial markets, with potentially catastrophic consequences.
According to a study by the Moody’s rating agency, in the event of a short-term default, the US economy would lose around two million jobs and enter a short-term recession. In the event of a default extended for a few months, seven million jobs would be lost, US GDP would fall by 4 percent by 2024 and financial markets would lose about a fifth of their value. Other studies estimate that any downturn in the US economy would contribute to an overall downturn in the global economy, with serious consequences around the world.
Furthermore, in the event of default, US government bonds would no longer be perceived as risk-free, and this would have long-term consequences, which would make it more difficult for the United States to finance itself on the markets and which would damage the country’s image as a more stable economy and reliable in the world.