Forbes India 15th Anniversary Special

US debt ceiling: Of political game theory and unsustainable debt

Is the market chatter around the US debt ceiling much ado about nothing? The concern isn't as much about a debt default, that's ruled out, but the fireworks that will begin once the contours of the last-minute deal are known. Here's why

Neha Bothra
Published: May 24, 2023 12:42:01 PM IST
Updated: Jun 1, 2023 03:19:54 PM IST

US debt ceiling: Of political game theory and unsustainable debtUS government is on the verge of potentially unleashing chaos across global markets as it is days away from exhausting the extraordinary measures the US Treasury implemented in January to honour its debt obligations after the government hit its debt limit. Image: Shutterstock
 
How much is $31.4 trillion? Well, roughly, it is enough to fill thirty-one National Football League stadiums. That’s how big the national debt is of the United States. According to the US Congressional Budget Office, it is set to cross $46 trillion in ten years, and the rising level of national debt has stoked a major political standoff over the debt ceiling, once again.  
 
Washington based Bipartisan Policy Center’s economic policy analyst, Arianna Fano, tells Forbes India, “The growing national debt poses a threat to private investment, labour market productivity, and public spending on critical government programmes. At nearly the size of the US economy and only growing—and with interest owed on the debt an astonishing 40 percent greater in just the first seven months of this fiscal year—policymakers of both parties must come together to explore solutions to the unsustainable fiscal path we find ourselves on.”  
 

US debt rose from $9.7 trillion in 2000 to $18.43 trillion in 2010 and $30.93 trillion in 2022, implying that the economy’s debt to GDP ratio more than doubled from 56 percent in 2000 to 124 percent in 2022. For economists and academicians, a debt default by the US, the world’s biggest economy, is thinking the unthinkable, as it’s considered to be an outcome that’s completely “off the table”.  
 
And, yet, once again, the US government is on the verge of potentially unleashing chaos across global markets as it is days away from exhausting the extraordinary measures the US Treasury implemented in January to honour its debt obligations after the government hit its debt limit. After a hostile deadlock, reportedly, talks between President Joe Biden and Republican leader Kevin McCarthy thawed, but no deal was struck as one the points of “serious differences” include a cutback in budget spending to the tune of $4.5 trillion.  
 
To ward off the damning repercussions of breaking the debt ceiling, the US government must race against time, diffuse the political stalemate, and stitch a deal to raise or suspend the debt ceiling by June 1, to borrow additional funds, failing which it will be unable to meet its social welfare commitments. This could lead to widespread economic pain, high borrowing costs, and high unemployment.  

US debt ceiling: Of political game theory and unsustainable debt
 
“We estimate that it is highly likely that the Treasury will no longer be able to satisfy all of the government’s obligations if Congress has not acted to raise or suspend the debt limit by early June, and potentially as early as June 1,” Janet Yellen, US treasury secretary, wrote in a letter to Kevin McCarthy, Speaker, House of Representatives, on May 22. “If Congress fails to increase the debt limit, it would cause severe hardship to American families, harm our global leadership position, and raise questions about our ability to defend our national security interests,” Yellen cautioned.   
 
In the letter, Yellen mentioned that there was a substantial increase in the Treasury’s borrowing costs for securities maturing in June, and outlined the deep economic impact of delaying a deal which could potentially harm the global status of the US dollar as a safe asset and its use as a reserve currency.     

Also read: Why India may find it hard to buck the global slowdown

 
“We have learned from past debt limit impasses that waiting until the last minute to suspend or increase the debt limit can cause serious harm to business and consumer confidence, raise short-term borrowing costs for taxpayers, and negatively impact the credit rating of the US,” Yellen stated.    

US debt ceiling: Of political game theory and unsustainable debt
 
Forbes India sent a detailed questionnaire to the US Treasury Department to find out if there are measures to cushion any potential delay in the government’s ability to meet critical obligations to government employees and citizens who depend on social security benefits. A response is awaited.  
 
“There is no established playbook for the US government if Congress fails to raise or suspend the debt limit—it would be an unprecedented economic event with significant domestic and global implications. Even a short-term default could lead to higher borrowing costs and liquidity concerns for the private sector, increased unemployment, stock market losses, and GDP contraction, which can be hard to stop or reverse,” explains Fano. 

According to some estimates and analysis of policy think tank organisations, the government is committed to spend over $187 billion in the first week of June to pay for Medicare, veterans’ benefits, pension, education programmes, and social security benefits. The White House forecasts the US economy could contract by over 6 percent if the debt ceiling is not raised soon. “Confusion over the possibility of missed or delayed cheques would likely grow rapidly as the standoff intensified and cause widespread confusion and income shocks for impacted households,” Fano adds. 

US debt ceiling: Of political game theory and unsustainable debt
   
Intriguingly, over 60 million US citizens avail government aid, but each time the debt ceiling mechanism brings the nation on the edge of a default and potential delay in critical payouts and benefits, there hardly seems to be any serious concern or action. The underlying reason for this unshakeable faith is the expectation that history will repeat itself and the US Congress will hammer a last-minute agreement to raise or extend the debt ceiling. An email sent to the American Federation of State, County and Municipal Employees remained unanswered.   

“Officials have long denied the existence of any ‘Plan B’ to finance government operations in a default scenario. While some have asserted that the Treasury could prioritise certain payments or delay all bills and pay them in full once enough revenue has come in, significant economic, operational, and legal uncertainty and risk abound,” Fano says. 

Since 1960, as per the US Treasury Department, the debt ceiling has been revised, extended, or raised on 78 occasions, and nearly 63 percent times it was under Republican presidents. To manage fiscal challenges, the US government is likely to consider the unpopular combination of lower government spending and higher taxes even as the economy is grappling with a slowdown. 

US debt ceiling: Of political game theory and unsustainable debt
  
“Correcting our fiscal imbalances must involve serious discussions, bipartisan negotiations, and legislative action that include reforming primary cost drivers like Social Security and Medicare, generating new sources of revenue, and fixing the broken budget process,” says Fano.  
   
On Tuesday, European markets traded marginally lower, and the STOXX Europe 600 Index was down 0.6 percent on debt ceiling concerns as talks between President Biden and House Speaker Kevin McCarthy ended on an inconclusive note. US stocks closed in the red: The S&P 500 benchmark index fell 1.12 percent, the Nasdaq Composite declined 1.26 percent, and the Dow Jones Industrial Average dropped 0.69 percent. Also, one month Treasury bill yields inched up to a record high of 5.88 percent.

Though a default is ruled out, Fano highlights what’s at stake for the global economy. As the saying goes, when the US sneezes, the world catches a cold. “The interconnectedness of the global financial system means that a US default could trigger a broader contagion effect. The future of the US dollar as the world’s main reserve currency could be threatened if global investors become reluctant to hold US dollar-denominated assets, leading to a decline in demand over time. These consequences could undermine confidence in the global banking system and potentially lead to a wider financial crisis,” says Fano. 

US debt ceiling: Of political game theory and unsustainable debt
 
US equity strategists have not priced a US debt default into the market. Most analysts agree that even if a deal is reached within the X-date it is likely to come with strings which will tie down federal spending and tip the economy towards a recession, indicating a downside risk for equities and non-government bonds. Moreover, until there is clarity on how the talks end, investors are moving out of riskier assets.    
   
Asian markets were mixed and Indian equities ended flattish. In India, market analysts and fund managers believe domestic equities are much more resilient than 2012, and markets have factored that the debt ceiling will be raised, eventually. Mahendra Jajoo, CIO- fixed income, Mirae Asset MF, says, “If a deal is not done until the last minute, of course there will be nervousness and some volatility in the market. But, at this point, there is an underlying belief that the situation will be resolved and to that end there is much less of panic in the market.”  
   
Joseph Thomas, head of research, Emkay Wealth Management, says domestic markets are not entirely insulated from these developments as the economies are coupled, and reverberations will be felt on both sides of the Atlantic as also in Asia. “If the current situation continues with no progress in the negotiations, it could result in either a short default or a long/protracted default. The credit default swap spreads have already widened in the recent past as the market is progressively pricing in the potential for a default. This could also lead to spiralling money market rates and also lower equity indexes,” he adds.