The US is headed for yet another standoff over the federal debt limit. House Republicans say they won’t raise the arbitrary cap on total borrowing unless President Joe Biden agrees to budget cuts. The Biden administration says it won’t negotiate, because Congress has already made the relevant spending decisions and the government must always honor its obligations.
The impending crisis probably won’t prevent the US from paying holders of its Treasury securities. But that’s no reason for complacency: Legislators’ brinksmanship can still do a lot of damage.
The government will hit the $31.4 trillion debt ceiling this week, according to Treasury Secretary Janet Yellen. This means the real deadline will come in June or so, when the Treasury runs down its balance at the Federal Reserve and runs out of extraordinary cash-raising measures, such as tapping government investment funds.
Despite the apparent determination of some Republicans, I expect disaster to be averted at the last minute, as it has been in the past. It’s hard to see how holding the government’s creditworthiness hostage is a winning political strategy. The perpetrators will be blamed for the consequences, just as they were blamed for government shutdowns during the Clinton administration. Beyond that, the narrow Republican majority in the House cuts both ways: It gives more power to the radical fringe, but also allows Democrats to prevail with just a few moderate defectors.
Suppose, though, that Congress fails to raise the limit. What then? Government spending will be limited to incoming revenue, which in summer months won’t be nearly enough to pay everyone. Most likely, the Treasury will prioritize paying interest and principal on its debt securities (delaying payment on a portion of its other obligations until the standoff is resolved) — an approach that House Republicans appear to support.
Even if some Treasury securities were to end up technically in default, the Fed is very likely to (as indicated in official transcripts from 2011 and 2013) continue to accept them as collateral for cash loans, albeit at market prices. The Fed might even intervene directly to support the Treasury market, though officials have been cagey about this for fear of making default more palatable to legislators.
Still, there’s vast potential for damage. Even if the debt limit is raised before the Treasury runs out of cash, financial markets will suffer. Previous standoffs, such as in 2011, led to significant outflows from Treasury money-market mutual funds into commercial banks, and to distortions in markets where people trade and borrow against Treasury securities — particularly for securities maturing during the period when the debt limit was likely to bite. It’s even possible that the government will fail to attract enough buyers at auctions of newly issued debt, as the primary dealers who are required to bid at each auction shy away from the risk of getting stuck with a large slug of Treasuries.
The closer Congress gets to the brink, the more it will undermine confidence in the US dollar as the world’s reserve currency and drive up the government’s borrowing costs, as investors demand higher interest rates to compensate for the risk. After a close call in 2011, Standard & Poor’s downgraded the country’s long-term credit rating to AA+ from AAA. And if Congress goes so far as to prevent the government from meeting its obligations, the shock will be severe, in large part because markets will be expecting a resolution until the very last moment.
The debt limit doesn’t contribute meaningfully to fiscal discipline. It encourages political grandstanding. It risks the default of the world’s wealthiest and most powerful nation. It should be abolished.
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