Consequences of Lifting the US Debt Ceiling

Last week the U.S. Senate passed a bill to suspend the national debt ceiling until January 1, 2025. The debt ceiling crisis was once again near-miss. According to my research, the U.S. has raised its debt ceiling at least 100 times in the last 82 years, under both Democratic and Republican presidents. In the immediate future the default crisis is resolved, and the suspension of the debt ceiling means that the U.S. government could be in the process to create another liquidity issue in the global financial market.

The year 2000 was the last year of President Clinton's second term, and it was also the healthiest fiscal year in the past 25 years. In 1998, the Clinton administration achieved a surplus of USD70 billion, the first surplus since 1969.

At the end of fiscal year 2000, the U.S. national debt was only USD5.67 trillion; before the end of President Bush’s second term in fiscal year 2008, the national debt exceeded ten trillion for the first time to USD10.24 trillion; when President Obama left the White House, it increased to USD19.6 trillion. After Donald Trump becoming the President, the national debt increased to more than USD28 trillion; when President Biden was only halfway through his term, the U.S. debt has exceeded USD31 trillion U.S. dollars, a surge of about 4.5 times compared to when President Clinton left office, while the U.S. GDP increased from USD10 trillion in the same period Increased to USD25 trillion in 2022, an increase of less than 1.5 times.

The U.S. government's interest payments are becoming increasingly burdensome, especially as it is forced to raise rates to fight inflation because of COVID-19. Just one year after Trump took office, the Fed raised interest rates and shrunk its balance sheet. The annual interest payment reached USD335 billion, a year-on-year increase of approx. 20%, while the U.S. government’s tax revenue was around USD3.3 trillion that year. As of 2022, the U.S. government's interest payments were USD736 billion, a 1.2-fold increase in four years. In the first half of the latest fiscal year, interest expenses increased by 32% year-on-year to USD384 billion. Market research estimates that the U.S. government’s interest expense for the entire fiscal year 2023 will not be less than USD800 billion, which is almost identical to the U.S.’s military budget (USD850+ billion).

Cutting expenditure is a good way to reduce the huge national debt level in the U.S., but it is not politically realistic from any angle. In my previous article (https://www.dhirubhai.net/posts/thomas-kwan-29504b1_growth-economicgrowth-economicoutlook-activity-6628198184286023680-wyJi?utm_source=share&utm_medium=member_desktop), technological breakthrough should be the engine to help increase national income and reduce debts. Unfortunately, there should be no miracle in the short term even with the introduction of powerful generative AI like GPT4,5,6. Historically, unstable world economic environment drove money to the U.S., which did help reduce its interest rates in the past (such as the global financial crisis in 2008), but this “policy” will no longer as effective as it used to be.

Putting aside the long-term issues for the time being, I believe the global US Dollar market may face another liquidity issue in the next 12-18 months. According to the analysis of major banks, after the suspension of the debt ceiling, the U.S. Treasury shall issue more than USD1 trillion in bonds within this year to supplement cash (if the annual interest expense is really going to be around USD800 billion, I would not be surprised to see even more bonds will be issued). This move is likely to suck liquidity from banks and money market funds and push up short-term interest rates, which will not only increase economic pressure, but could even trigger another wave of unexpected bank failures. Of course, if those to-be-issued bonds are going to be undertaken by major overseas funds and/or sovereign funds, the crisis may be temporarily shifted to other nations. However, the question that we need to ask ourselves is, will the European financial industry and the EU government, which have already been weakened by the war in Ukraine, be willing to buy those bonds? Will other traditional big buyers of U.S. bonds such as Japan, China, and the Middle East still going to be willing buyers in the long run?

I don’t have a crystal ball to answer the above-mentioned questions but more and more countries are going to use different means (e.g. currency swap) to reduce their exposure and dependence on the U.S. Dollar is seemingly inevitable.?