United States Treasury Secretary Janet Yellen has declared that the US has hit its federal debt limit, kicking off an intense political battle that puts the global financial system at risk.
Congress and the White House have until at least early June to resolve the issue.
The very phrase “debt ceiling” sounds austere and restrictive, as if it’s a lid on government spending. In fact, this cap on United States government borrowing affects only the ability to pay existing bills, not to approve more spending.
But it has become an explosive political issue with the potential to roil financial markets, since a failure to raise the ceiling could eventually result in a first-ever default on some of the government’s obligations.
Here is what you need to know about the situation.
Why is there a debt ceiling?
Its creation, in 1917, made it easier to finance World War I by grouping bonds into different categories, easing the burden on Congress to approve each bond separately.
With World War II looming in 1939, Congress created the first aggregate debt limit and gave the Treasury Department wide latitude on what bonds to issue.
Raising the ceiling lets the government borrow to cover the gap between spending and taxes already approved by Congress.
When did it become a political issue?
The limit was routinely raised without incident until 1953. That year, approval was held up in the Senate in an attempt to restrain president Dwight Eisenhower, who had requested an increase to enable the construction of the national highway system.
The limit has since been raised dozens of times, usually without a fight; both parties agreed to hikes under Republican president Donald Trump without a fuss, for instance.
But the past quarter century has seen the debt ceiling increasingly become a partisan weapon.
What were the biggest fights?
Raising the debt ceiling was among the disputes that caused two shutdowns of the federal government in late 1995 and early 1996.
Another fight occurred in 2011, rattling financial markets and prompting Standard & Poor’s (S&P) to issue the first-ever downgrade of the US government’s credit rating.
Consumer confidence plummeted as did poll ratings for Republicans in Congress and then-president Barack Obama, who agreed to more than US$2 trillion in spending cuts over a decade to end the crisis.
A second debt-ceiling face-off between Obama and Republicans occurred in 2013 as part of a doomed GOP effort to undo the Affordable Care Act. It resulted in the cap being suspended for the first time.
What is the issue now?
The US is bumping up against the current federal debt limit of nearly US$31.4 trillion. Treasury Secretary Janet Yellen says that special accounting manoeuvers should avert a crisis until early June.
These so-called extraordinary measures include withholding regularly scheduled contributions to a federal employee retirement fund and using that money to keep paying debts.
Once those measures are exhausted, the options get more dire, potentially leading to a partial government shutdown and delays in government payments like Social Security checks.
Defaulting on debt would “needlessly plunge the country into economic chaos, collapse and catastrophe while giving our competitors like China a historic boost” said a spokesman for President Joe Biden.
What would be so bad about a default?
Failure to pay holders of US government bonds would make them less desirable as investments, forcing the government to pay more in interest to sell them. That would have cascading effects.
“Financial markets would lose faith in the United States, the dollar would weaken and stocks would fall,” the Council of Economic Advisers, part of the White House, wrote during a debt ceiling debate in 2021.
“The US credit rating would almost certainly be downgraded, and interest rates would broadly rise for many consumer loans, making products like auto loans and mortgages more expensive for families who are subject to interest rate changes or taking out new loans.”