U.S. hits infamous debt limit. What it means and what happens next

A standoff over the US debt ceiling has begun. It could be the country’s most important political contest this year, with global economic ramifications.

Treasury Secretary Janet Yellen announced Thursday that the nation has reached its debt limit and must take extraordinary steps to delay a dangerous and unforeseeable US debt default.

We can witness months of escalating drama.

It began almost inexplicably with the measures announced Thursday: the US government, its ability to borrow money is now limited, will suspend contributions to the pension plan of federal employees.

Tensions are likely to increase this summer, as Washington takes increasingly desperate measures to meet its scheduled debt repayments.

That is unless the US political parties reach a spending deal.

The rest of the world will have questions and understand, because everyone is responsible for what comes next. After all, in this standoff, the global economy is hostage, the Republican Party has its demands and the debt ceiling is its weapon.

Here are some of those questions, answered.

What is the US debt ceiling?

US Constitution give Congress power through public finances, and Congress has always played several roles in approving debt levels. This created the first modern debt ceiling in 1939.

It’s just what it sounds like: the maximum level of US debt. Parliamentarians should raise it dozens times in the past year.

The US owes money to people and institutions around the world, two-thirds in the US and one-third abroad. They include buyers of government-issued securities like bonds and Treasury bills, such as pension funds, mutual funds, ordinary investors, the US Federal Reserve or other central banks – with Japan, China and the UK at the top of the list.

The country is experiencing historic debt levels: the debt ceiling was last increased two years ago to the current level, $31.4 trillionor more than 120 percent of US GDP.

The U.S. technically reached that limit Thursday; disaster, however, can be delayed by several months.

Many economists hate this system. In one economist survey84 percent agree it creates unnecessary uncertainty in the economy.

The normal way to set the debt level would be with a regular spending bill, when Congress approves the expenses, said Lee Roberts, who teaches public budgeting at Duke University.

“I don’t think it’s worth it [this way]” said Roberts in an interview.

What happens if Congress doesn’t raise the limit?

Bad stuff. A report by Moody’s Analytics is filled with scary adjectives like “cataclysmic,” “unimaginable” and “devastating.”

Moody’s foresees the effect on par with post-2007 financial crisis: GDP decline of almost four percent, almost six million lost jobs and stock prices plunging almost one-third. Old school published by the US Federal Reserve, the forecast is the same, if a little less dire, the result is Moody’s.

It is only a short-term effect. The long-term problem is that new risks are embedded, permanently, in the world economy.

The global financial system is built on the fundamental assumption that US government-backed securities are safe and readily available investment assets, says Marc Goldwein.

If there’s a global recession caused by this, it’s because long-held assumptions are confused, said Goldwein, an economics professor and vice president at the Committee for a Responsible Federal Budget in Washington.

Look at what happened in 2011: during the last debt-ceiling crisis, the mere talk of a possible US debt default led to the first credit downturn in American history, which wiped out seven percent of the stock market in one day.

Why are we discussing this now?

Because the situation is similar to 2011. There is a perfect political storm. Republicans have just won the House of Representatives, and they are ready to fight Democrats in the White House and the Senate.

Remember the recent melodrama in Congress that took more votes to elect a Speaker than at any time since the US Civil War? The debt ceiling played a role in it.

Conservative supporters have made a number of demands on Kevin McCarthy, one of which is that he negotiate before agreeing to lift the debt limit.

Conservatives want to cut spending, and see the federal deficit as unsustainable. They are not alone. What we don’t know is the bottom line: it’s not clear what kind of cut we want.

However, we know that McCarthy has to make the members happy. Even a small uprising, with only a few members, can harm the project you want today.

What will actually happen in the coming months?

Don’t think of debt as an on or off light switch. It’s more like an ebb and flow, growing steadily more dangerous.

We can actually watch the tides in: Ing daily statements, the US Treasury presents cash flows. Using these data, Treasury’s Debt Management Office decide when to borrow money. That guide at Bureau of Fiscal Services to get that money by issuing securities, like Treasury bills and bonds that will be repaid.

This activity stops when the debt limit is reached.

Cash is getting tighter, and the Treasury is resorting to extraordinary measures that Yellen mentioned, such as suspending pension contributions. This happened in 2019 and 2021and it will start again.

There was a brief reprieve for the federal treasury in the spring. Taxpayers send checks with annual returns. But the tide kept rising, and the cash kept dwindling.

Federal contractors will be notified, at some point, of final payments.

Beyond that, you can see what happened in California 1992 and 2009: Citizens get IOUs in the mail instead of normal benefit checks.

At this point in financial flailing, the government is doing whatever it can before taking the ultimate panic step: defaulting on bond payments.

The US will likely face this situation in the fall – Goldwein calls this uncharted territory.

He was an optimist: He didn’t think it would come. He believes the two parties will agree to a deal, and that the Republican House and Democratic Senate will agree to a new debt limit.

“I don’t even want to guess [what happens next]”said Goldwein. “Because I don’t think even our politicians are stupid enough to get to that point.”

What do the politicians say?

McCarthy, for his part, said he wants to start negotiations as soon as possible. He showed a 2019 agreement where the ceiling is raised in exchange for cutting the editing budget.

Republicans say spending must be reined in at the expense of exploding debt amid triple-whammy inflation, higher interest rates and persistent deficits.

According to the Congressional Budget Office, only paying interest on debt will cost $2.5 trillion more in the next decade than previously expected. (This, for context, is more than the US spendmore than one year, in military and old age pensions, combined.)

The parties must agree on how to reduce the deficit.

Democrats argue that there is a revenue problem. Past tax cuts under Republican presidents coincide with worse budget deficits in the era of Reagan, Bush and Trump. Republicans focused on cuts to spending programs.

The White House’s position on this point is: No negotiations. He said Congress has a basic duty to pay bills that have been passed, from spending that has been approved by Congress.

“There will be no hostages,” said White House spokeswoman Karine Jean-Pierre.

That position may not be sustainable.

The basic fact is that the House of Representatives has the power here. It takes two chambers to raise the debt limit. Republican leaders are told by their members, in no uncertain terms, to use their power.

And the pressure on McCarthy’s war will only grow in the coming months as conservatives talk radio and TV warn against caving.

Even President Joe Biden seems to recognize this will not be automatic: He recently mentioned the long days he did in 2011, including in It’s Evediscuss a give a deal to prevent the debt crisis. It takes nearly $1 trillion to cut spending.

“We can always work together,” Biden said.

However, the deal happened under John Boehner. The chairman of the House of Representatives of the Republic at that time must try to get enough members to pass.

Can McCarthy achieve the same?

In her memories, Boehner mentions McCarthy only one time – it’s related to the debt-limit war in 2011. And it’s not free. He viewed McCarthy’s behavior in the crisis as weak, saying he had failed in his leadership duties and stormed out of the room before Boehner could ask why he was bailing on a budget deal.

“[That] really pissed me off,” Boehner wrote.

that incident, Boehner said, contributed to him eventually bypassing McCarthy as the heir apparent to the job of Speaker; said Paul Ryan has shown leadership qualities by standing firm and voting for the budget deal.

Well, here it is again.

This time, McCarthy is in charge. The hardliners have more control.

And some moderate worries from both parties have begun initial discussion about employing rare parliamentary tactics to pass McCarthy and force a debt-ceiling vote.

It’s a longshot.

Whatever happens, Duke University’s Roberts hopes that if there is a deal, the sooner the better: “Because the consequences are so dire, you hope you get a resolution.”