Hot Take on the Debt Ceiling Crisis

As I received multiple questions about this topic, here is my opinion on reaching the American debt ceiling and the scenarios ahead.

What, When & Where?

The $31.4 trillion debt ceiling was reached on January 19th, 2023 week but will probably have no effect on the average American unless the US wants to accelerate its downfall against global competitors such as China & India.

For background, the US hasn’t had an annual surplus since 2001- meaning that its revenues (tax proceeds...), have not exceeded its costs- making them raise debt issued by the Treasury to pay for Social Security/ Medicare benefits, tax refunds, military salaries and interest payments on the outstanding national debt. Without the ability to raise more debt, the US has fewer options to meet its payments. Janet Yellen will probably suspend certain investments into federal retirement and postal programs to give the US a longer runway until June 2023. However, after this date, the US will need to find a solution.

The solution & why no one should panic.

Raising the limit is the obvious solution to enable the government to borrow more. It would not be the first time the US raises its debt limits. The next one will be the 46th raise in the past 40 years. The last one was in 2011 and its main effect was a downgrade in its credit rating (Standard & Poor’s rating downgraded the USA from AAA to AA+) and a 17% downturn of the S&P 500 that year, with even more negative pressure on government-related companies. The US never defaulted on its debt and will take steps to avoid default due to its reputation as the benchmark for risk-free assets. Interestingly, the newly raised debt would cover spending already approved by the Congress, therefore, avoiding solving the real problem which is the efficiency of the US government to produce a surplus.

If the US were to not raise the ceiling for whatever reason after June, the government would eventually fail to pay back its debts, including interest payments on Treasury bonds, putting the U.S. government in default. The U.S. has defaulted on its debt just once before, in 1979 but paid soon after. Today, a default would trigger a downgrade in the U.S. credit rating resulting in the raise of rates on other types of debt (mortgages, auto loans,etc) to account for the additional risk. Secondly, government spending would be cut in a default scenario further pushing us into recession territory (increasing unemployment etc.)

Once again, default is highly unlikely thanks to the US dollar. If any government defaulted on its debt, it would be because it didn’t have the currency the debt was owed in but in the U.S’s case, the debt is in a currency it can print if needed. On social media, some people have fallen in love with a particularly creative theory where Yellen could use her currency-minting powers to create $1 Trillion coin deposited with the fed that would allow the federal government to draw on the funds as needed and continue paying its bills until a deal was reached or until the $1 trillion was spent and another coin minted. However, this has been dismissed by Yellen as a gimmick.

If someone can mess it up, it's a politician.

In conclusion, in most cases, the debt limit will be raised and/or the balance sheet will be restructured which will probably have a minor effect on the average American. However, if a default were to occur, which is highly unlikely, I believe it would be the result of a political decision that would send the US into a tailspin. In this political scenario, the Republicans in the House of Representatives stand their ground and maintain that they won’t agree to raise the limit unless the Biden administration agrees to cut its spending. With countries such as China & India gaining ground in the global economic competition, a US default would trigger a series of events devaluating the dollar, making the US economy and financial markets weaker. Global investors and global economic actors will be pushed into investing elsewhere creating a negative feedback loop. A political spat of this magnitude would simply symbolize the failure of all its participants and be remembered as the tipping point where the US lost its global dominance.

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