The Debt Ceiling Stand-Off

Debt Ceiling

Has the rancorous political divide in America between Democrats and Republicans made it impossible for President Biden and House Majority Leader Kevin McCarthy to have a normal negotiation to avert a US Government default, triggering a likely major international crisis? Will the pressure from the extremes of both Parties exhibit the enormous dysfunction of the political system in the US in 2023 and oblige the two protagonists to face off like cowboys in a Western movie, each seeking to force the other to back down first, with the full faith and credit of the United States at risk?

The fight is over the Federal Government debt ceiling. Under the US Constitution, Congress alone has the authority to borrow money to pay government obligations; Congress has delegated that authority to the US Treasury, but for many years, Congress had to approve every new Treasury borrowing. In order to make this cumbersome process more efficient, during World War I when the government needed to borrow large amounts, Congress gave the Treasury advanced approval to borrow up to a debt ceiling which at the time was far higher than immediate borrowing needs. But since the US Government, like most governments, spends more than it receives in taxes and other revenues, total debt continues to increase to regularly run up against the previously approved debt ceiling, requiring that both Houses of Congress approve an increase.

For decades, when Democrats and Republicans were used to working together, a bipartisan majority in Congress would approve needed increases in the debt ceiling virtually automatically, but over the last 15 years, with growing partisan divide, the debt ceiling issue has been an opportunity for the Party that does not control the Presidency to force changes in Administration policies. Fights over the debt ceiling have become increasingly acrimonious; in 2021, President Obama was forced to accept Republican demands for spending cuts, barely averting the drama of a US default on the timely payment of its debt obligations. That close call led to a downgrade in the rating of US Government debt, losing its coveted AAA rating. And so we have a Congressional process chosen to make things more efficient become a major stumbling block.

The $24 trillion US Treasury market – by far the largest debt market in the world – serves as the backbone of the international financial system, a default by the US, even a brief one, would create havoc in the market with consequences that may legitimately be considered “catastrophic”, with severe short-term financial and economic downturn in the US, widespread economic suffering and a huge medium and long-term negative impact on the reputation of America. Democratic and Republican leaders, all have agreed that default “cannot be allowed to happen”. But when two negotiating parties are as far apart as are the two Political Parties in Washington, and things get pushed to the brink, a US Government default is no longer unthinkable. And Secretary of the Treasure Janet Yellen has emphasized she is not bluffing when she repeatedly warned Congress that the US would be unable to honor its financial obligations beginning on June 1, 2023 unless Congress increased the debt ceiling.

The issues are fundamentally political, not economic, with both sides appealing to the public for support. President Biden has every right to claim the moral high ground, insisting that Congress has already approved expenditures and that any discussions on government spending should be part of the annual negotiations on the budget, not on the artificial impact of the debt ceiling. He also could rightfully claim that Democrats did not use debt ceiling blackmail against the Trump Administration and that Republicans had accepted without difficulty Trump’s addition of $7 trillion to the national debt, whereas now, with a Democratic President, suddenly Republicans decry any increase in government debt. But Kevin McCarthy may have the political upper hand, he understands that debt is an unpopular concept to the American public, and that it is politically attractive to present the Democrats as profligate spenders, while the Republican Party is fiscally responsible. In addition, to the surprise of many, he was able to pass in the Republican-controlled House a bill proposing that the Government drastically reduce expenditures, basically cancelling much of Biden’s agenda. Such a bill had no chance of being approved by the Democratic-controlled Senate, but it presented a clear program to reduce spending in exchange for an increase in the debt ceiling, whereas the Democratic program was to increase the debt ceiling without any quid pro quo.

Biden initially said he would not negotiate any expenditure reduction, the debt ceiling had to be freely raised for the government to pay for expenditures already voted by Congress, but the Republicans clearly threatened to force a default, and the Democrats understood they would be blamed for such a result. Biden backed down, agreed to negotiated with McCarthy and even canceled his trip to Australia and Papua New Guinea (to their great disappointment) to return to Washington immediately after the G7 Meeting in Japan to pursue negotiations. Democrats, particularly in the liberal wing, are unhappy to see Biden accept Republican demands. McCarthy has his own political problems, he has a tiny majority in the House, and to win the election to become Speaker he had to accede to the demands of a small extreme right wing of his Party. This group, as well as ex-President Trump, seem quite willing to push the country to default and are ready to remove McCarthy as Speaker if he agrees to a deal with Biden that does not accede to their demands. In the poisoned political environment of US partisan politics, both sides have very limited room to maneuver.

The US has never failed to make a debt payment. As we get perilously close to the deadline, might this be the first time? And if ever there were a default, even a brief one, who will get the blame? As of this writing, Biden and McCarthy appear to be negotiating in good faith, both recognizing the enormous danger a default would represent for the country. I suspect they will come to an agreement, barely averting a default, but once again showing for the world to see, the weaknesses of the dysfunctional US political system.

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