What is the debt ceiling, and how can confrontation affect consumers

The US is likely to reach the debt limit tomorrow

The United States may be about to reach its debt ceiling.

Treasury Secretary Janet Yellen said last week that the US would likely hit the ceiling on Thursday. Absent steps by Congress, the event could “cause irreparable harm to the American economy, the livelihoods of all Americans, and global financial stability,” she wrote in a letter to new House Speaker Kevin McCarthy of California.

Here’s what the debt ceiling is and what makes it so important to consumers.

What is the debt ceiling?

The debt ceiling is the amount of money the US Treasury allows to borrow to pay its bills.

These liabilities include Social Security benefits, Medicare, tax refunds, military payroll, and interest payments on outstanding national debt.

The current cap is about $31.4 trillion. Once it is hit, the US is unable to increase the amount of its outstanding debt – and it becomes much more difficult to pay its bills.

More personal finance:
4 major movements of money in an uncertain economy
Why are smartphones, used cars and bacon so low in 2022?
Evacuations began to spread across the United States

“Unlike many households, the government relies on debt to fund its liabilities,” said Mark Hamrick, Bankrate’s chief economic analyst. “And like many families, they do not have enough income to fund their expenses.”

The debt ceiling will not be a problem if US revenues – that is, tax revenues – exceed its costs. But the United States has not run an annual surplus since 2001 — and it has borrowed to fund government operations every year since then, according to the White House Council of Economic Advisers.

Why is the debt ceiling a problem now?

While the US is expected to reach its borrowing cap of $31.4 trillion on Thursday, that in and of itself is not the main issue.

The Treasury has temporary bill-paying options: It can use cash on hand or spend any incoming revenue, such as that during tax season, which begins Jan. 23.

They can also use so-called “extraordinary measures,” which save money in the short term. Yellen said the Treasury Department will begin using such measures this month. They include the recovery or suspension of investments in certain federal retirement and disability funds. The full funds will be made later.

These maneuvers aim to prevent a potential catastrophe: default.

The debt ceiling debate escalated in the House of Representatives

A default may occur if the United States runs out of funds to meet all of its financial obligations on time — for example, losing a payment to investors who hold US Treasury securities. The United States issues bonds to raise money to finance its operations.

The United States defaulted on its debt only once, in 1979. The Treasury Department said a flaw in its technical bookkeeping led to a delinquency in bond payments, an error that was quickly corrected and affected only a small share of investors.

Yet the United States did not “intentionally” default on its debt, CEA economists said. It is this outcome that Yellen warned would cause “irreparable harm”. Economists said the scale of negative shock waves is unknown because it has never happened before.

“The implications are serious,” said Mark Zandi, chief economist at Moody’s Analytics.

“It would create chaos in the financial markets and completely undermine the economy,” he added. “The economy will enter a severe recession.”

The fallout: frozen interest, recession, more expensive borrowing

It is difficult to set an exact default date due to the volatility of government payments and revenues. Yellen said that is unlikely to happen before early June.

Congress could raise or temporarily suspend the debt ceiling in the meantime to avoid a debt-ceiling crisis—something lawmakers have done many times in the past. But the political deadlock calls into question their ability or willingness to do so this time around.

[A default] It would create chaos in the financial markets and completely undermine the economy.

Mark Zandi

Chief Economist at Moody’s Analytics

If the United States defaults, it will send many negative shock waves through the United States and global economies.

Here are some of the ways it can affect consumers and investors:

1. Federal frozen benefits

The CEA said tens of millions of American families may not get certain federal benefits — such as Social Security, Medicare and Medicaid, and federal aid related to nutrition, veterans and housing — on time or at all. Government jobs such as national defense could be affected, if the salaries of active-duty military personnel are frozen, for example.

2. An economic recession with job cuts

Affected families will have less cash on hand to inject into the US economy, Hamrick said – and a recession appears “inevitable” under the circumstances. The recession will be accompanied by thousands of job losses and high unemployment rates.

3. High borrowing costs

Investors generally view US Treasury bonds and the US dollar as a safe haven. Bondholders are confident that the United States will return their money with interest on time.

“It is sacred in the US financial system that US Treasury debt be risk-free,” Zandi said.

If that is no longer the case, Zandi said, rating agencies will likely downgrade the credit rating of the US pound, and people will demand much higher interest rates on Treasuries to compensate for the additional risk.

Borrowing costs will rise for American consumers, because interest rates on mortgages, credit cards, auto loans and other types of consumer debt are tied to movements in the US Treasury market. Companies will also pay higher interest rates on their loans.

4. High fluctuations in the stock market

Of course, this is assuming that businesses and consumers can get credit. There could also be an “acute” financial crisis, Hamrick said, if the US government is unable to issue additional Treasury bonds, which are an essential component of the financial system.

“The default will send shock waves through global financial markets and is likely to cause credit markets to freeze around the world and stock markets to plunge,” the agency said.

Even the threat of default during the debt-ceiling “crisis” of 2011 caused Standard & Poor’s (now S&P Global Ratings) to downgrade the US credit rating and caused huge market volatility. Mortgage rates rose by 0.7 to 0.8 percentage points for two months, the agency said, and then slowly declined thereafter.

Leave a Comment