EXPLAINED: What’s US debt ceiling & why is it such a big deal?

US has hit its borrowing limit also known as the debt ceiling fueling fears of putting global markets in instability and setting off a budgetary battle in Congress. The looming debt ceiling crisis is unsettling investors too as any default will lay a major impact on the international financial markets. So what exactly is the debt ceiling and why is it such a big deal? 

The debt ceiling determines how much money the US government can borrow in order for its expenses. However, after the borrowing cap is reached, the Treasury is not permitted to issue any further bills, bonds, or notes. In this situation, the only source of funding for it is tax revenues. Currently, the ceiling equates to around 120% of the nation’s yearly economic output. 

The borrowing cap is determined by US Congress and it is presently set at $31.4 trillion. The federal government uses borrowed money to help pay for costs included in its budgets, such as social security and Medicare payouts and the salaries of US military personnel.

Janet Yellen, the US Treasury Secretary stated last week that without raising the ceiling, the government could only pay its payments through early June. Yellen said that “extraordinary measures” are now being used to stop the United States from going into default on its financial expenses. However, Yellen’s estimate for the “drop-dead date” is earlier than some experts had predicted over the time by which the US will exhaust its borrowing limit.

Many experts believe that the debt ceiling could occur somewhere in the third or fourth quarter. According to Jonathan Cohn, Head of Rates Trading Strategy at Credit Suisse in New York, the debt ceiling may be hit between September and early November. According to Goldman Sachs, the debt ceiling would be hit between the months of August and October. 

The debt ceiling has to be raised in light of the current circumstances in order to make room for the US government to continue making payments and prevent a default. The political situation is not as favourable, though. Republicans run the House of Representatives, while Democrats run the Senate. Congress is reluctant to raise the debt ceiling because it might provide Republicans with leverage when negotiating spending cuts.

Speaking over the debt ceiling crisis, newly appointed US House Speaker, Kevin McCarthy in a conversation with Fox News said, one could not just keep increasing the debt ceiling. “Let’s sit down and change our behavior for the good of America. Because what we’re going to do is bankrupt this country and bankrupt these entitlements if we don’t change their behavior today.” On the contrary, White House press secretary, Karine Jean-Pierre, said the administration would not be doing any negotiations and if debt ceiling is to be raised it should be done without condition. 

There could be a number of things which could trigger if the debt ceiling is not raised. First off, if US government is unable to borrow more money it will put existing federal programs at risk. Secondly, if this verbal battle is not resolved and no further action to address the situation is taken, investors will start to fidget. What will actually happen? Investors may lose trust in the US dollar if the federal government defaults on its expenses, which would weaken the greenback, cause stock prices to drop, and result in job losses.

The United States was on the verge of default in 2011 due to political deadlock in Washington over the debt ceiling. It caused the stock markets to crash and cost the nation its top-tier AAA credit rating from Standard & Poor’s. The S&P 500 plummeted 15% during the 2011 crisis, according to a research report from Goldman Sachs, while firms with the highest sales exposure to US federal spending had a 25% decline.

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