Washington risks triggering a global financial crisis if politicians are not able to raise the debt limit, global banks, the US Treasury and even the President is warning.
The clock to doomsday is already ticking: The US hit its $31.4 trillion debt ceilling on Thursday and has already started “extraordinary measures” to buy more time.
The unthinkable is becoming ever more likely and the US could default on its debt as early as June.
The size of America’s public debt is eye-popping — it is about 120 per cent of US GDP — and Washington is scrambling to meet its obligations to avoid financial armageddon.
President Joe Biden says he will “have a discussion” with Republican House of Representatives Speaker Kevin McCarthy about raising the US debt ceiling as the nation edges dangerously close to default. But any deal with the Republican-controlled House comes with major strings attached and the stand-off is just beginning.
JPMorgan Chase boss Jamie Dimon warned on Friday that a failure to raise the limit would be catastrophic.
“We should never question the creditworthiness of the United States government. That is sacrosanct, it should never happen,” Mr Dimon said during an appearance on CNBC’s Squawk Box.
“Of course, Democrats can blame Republicans and the Republicans can blame the Democrats. I don’t care who blames who — even questioning it is the wrong thing to do,” Mr Dimon added. “That is part of the financial structure of the world. This is not something we should be playing games with at all.”
“Americans should understand that the American financial system is basically the crux of the financial system of the world and we shouldn’t play with it.”
Congress remained deadlocked this week. The stalemate raised the risk of an unprecedented and potentially catastrophic US debt default unless Democratic and Republican leaders can reach an agreement.
Treasury Secretary Janet Yellen informed Mr Mr McCarthy on Friday that her department had enacted “extraordinary measures” to maintain government operations.
The manoeuvres will reportedly keep the government functional through to June 5.
“I respectfully urge Congress to act promptly to protect the full faith and credit of the United States,” she wrote in the letter.
Sharing the tone of Mr Dimon, a seperate letter from Dr Yellen last week stressed that a US debt default would “cause irreparable harm to the US economy, the livelihoods of all Americans, and global financial stability.”
Republicans hold just a slim majority in the House and are so far refusing to vote in favour of raising the debt ceiling without spending cuts.
The White house remains firm the limit should be raised “without conditions.”
White House press secretary Karine Jean-Pierre said this morning there was a non-negotiable “duty” to raise the limit.
“Like the President has said many times, raising the debt ceiling is not a negotiation; it is an obligation of this country and its leaders to avoid economic chaos,” she said.
“Congress has always done it, and the President expects them to do their duty once again.
“That is not negotiable.”
What is the US debt limit?
The US debt limit, also referred to as a debt ceiling, was introduced more than a century ago to limit the amount the federal government was allowed to borrow.
It’s been raised periodically ever since to avoid a default – most recently in 2021, when it was raised to the current level of US$31.4 trillion.
The debt is owed to people and institutions around the world, one-third of whom are outside the US. They include any buyer of government-issued securities like bonds, as well as the US Federal Reserve and other central banks – with Japan, China and the UK atop the list.
When the US government comes close to the ceiling, numbers can be crunched to buy a little more time, such as the “extraordinary measures” Dr Yellen said would be introduced in coming weeks.
Eventually, however, the accounting tricks run out, and the debt ceiling can’t be avoided – it has to be raised, or chaos erupts.
What happens if the US defaults on its debt?
If the US were to default on its debt, economist generally predict chaos would ensue.
Goldman Sachs last month warned that a mere close call could set off turmoil on Wall Street, devastating the retirement accounts and investment portfolios of everyday Americans.
“It seems likely that uncertainty over the debt limit in 2023 could lead to substantial volatility in financial markets,” Goldman Sachs economists wrote.
A failure to raise the debt limit in time would “pose greater risk to government spending and ultimately to economic growth than it would to Treasury securities themselves,” they said.
The shifting of funds to avoid a crisis could impact other payments, including social security and veterans’ benefits, Goldman Sachs added, saying “a failure to make timely payments would likely hit consumer confidence hard.”
A recent report by Moody’s Analytics, too, described the possibility the US could default on its debt as “devastating” and “unimaginable”.
They predicted six million jobs would be lost, the country’s GDP would decline by almost four per cent, and stock prices would plunge by almost one-third.
Longer term, however, a default could permanently embed uncertainty into the world economy, devastating the assumption that the US government is a reliable body in which to invest.
In 2011 – the last time the debt ceiling debate looked particularly dire – mere talk of a default caused the first credit downgrade in US history, wiping seven per cent from the stock market in a single day.
In her letter to Mr McCarthy, Dr Yellen urged politicians to “act in a timely manner” either to increase or suspend the debt limit.
“Failure to meet the government’s obligations would cause irreparable harm to the US economy, the livelihoods of all Americans, and global financial stability,” she wrote.
Why does the US have a debt limit?
Many politicians are opposed to having a debt ceiling at all.
Democratic Senator Elizabeth Warren, for instance, has said she would “get rid of the debt ceiling altogether”, claiming it “serves no function except to create leverage”.
In one survey, 84 per cent of American economists agreed it created unnecessary uncertainty.
Texas Republican Dan Crenshaw, on the other hand, called the debt limit a “necessary evil”.
“It’s the only time that you can actually negotiate ways to get out budget under control,” he said.
Many countries have racked up considerable debts over the pandemic, including Australia, where the national debt is just shy of $1 trillion. Australia previously had a debt ceiling of $300 billion, which was abolished in 2013. Raising the debt ceiling doesn’t necessarily make way for yet more government spending. Typically, it is only done so that Congress can repay the bills the US already owes.
– With the New York Post