How Does The Debt Ceiling Work And Why Is Yellen Talking About Catastrophe?

Congress must reach an agreement to increase the federal borrowing limit, or debt ceiling before the government runs out of money to continue its spending programs and pay its creditors in October. Although this House passed a measure that should keep the government access to debt until early December (and would suspend the ceiling temporarily until 2022), the bill faces a bloody battle in the Senate. The whole country is pending.


This debt ceiling arose during the world wars of the 20th century, in response to the need for Congress to specifically approve loans for each purpose. Since then, the limit has been raised or changed 98 times, according to the Congressional Research Service. Despite constant disagreements between the parties, Congress and the president have never allowed the US to stop paying its obligations, according to The Wall Street Journal (WSJ).

Debt ceiling and shutdown

Although on several occasions the Federal State has had to close and leave its officials at home due to lack of liquidity, this is not due to the famous debt ceiling, this fact is different and is known as shutdown (it is the closure of the Administration), and supposes the temporary closure of the services of the federal Administration when Congress does not reach an agreement on its budgets. Imagine that here in Spain all state officials had to go home (without charge) if the PSOE does not reach an agreement on the General State Budgets. The problem in the US is that this year the arrival of the spending ceiling and the budget negotiation coincide. 

Returning to the debt ceiling, this limit from which the US Treasury cannot issue more bonds and bills is currently set at $ 22 trillion, an amount that the US Government has exceeded (the debt is at about $ 29 trillion). trillions of dollars right now, about 20 times the economy of Spain ) because the limit is temporarily suspended (in addition to having a limit, it can be suspended). The deadline to reach a budget agreement is next Thursday, September 30.

While it is true that the Treasury has some cash reserves (about $ 300 billion well kept at the Fed), this money will run out quickly, preventing it from paying government bills on time. Approaching the deadline without a plan can have consequences.

In 2011, Standard & Poor’s, for example, lowered the US credit rating from triple-A to double-A when Congress came close to not extending the ceiling. This downgrading of the credit rating increased the Treasury’s borrowing costs by about $ 1.3 billion that year, according to the Government Accountability Office, amid rising interest rates.

If the government runs out of cash, it could be forced to cut and turn off the tap on some key payments, such as the part of pensions granted to Social Security (in the US most pensions are private), social benefits from veterans, covid aid, salaries for federal employees and members of the armed forces, or interest on the debt.

Goldman Sachs estimates that the Treasury would have to cut 40% of its current disbursements, including some to US households, if the ceiling is not raised or that ceiling is temporarily suspended. Right now, the US is deploying very ambitious fiscal policies that need constant funding. The activity of the Treasury issuing debt has been frantic in recent months.


Yellen’s fear

With all this, it is expected that the Treasury will run out of cash sometime in October and reach a deadline in which the US government will default or default for the first time.

“A delay that calls into question the ability of the federal government to meet all of its obligations would likely cause irreparable damage to the US economy and global financial markets,” Treasury Secretary Janet Yellen said earlier this month in a letter. to Congress.

“We have learned from past impasses on debt limits that waiting until the last minute to suspend or increase the debt limit can cause serious damage to business and consumer confidence, increase the costs of borrowing at short term for taxpayers, and negatively affect the US credit rating, “Yellen added.

Republicans, Democrats, and economists acknowledge that the consequences of a default would be catastrophic and likely the prelude to a recession.

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