The US may now be closer than ever to defaulting on its debts

The farcical 15 rounds of voting to elect the new Speaker for the US House of Representatives has set up a collision between Republicans and the White House that could roil global financial markets and even precipitate another global financial crisis.

Among the myriad of concessions Kevin McCarthy agreed to in order to secure the position was a promise not to raise the US debt ceiling without major cuts to spending.

The debt ceiling is unique to the US among the major economies. Increasing it doesn’t authorise or enable new spending but simply allows the government to finance existing, Congress-approved, measures.

Republicans are expected to use their power in the US House of Representatives to trigger a debt ceiling crisis. Credit:AP

With current federal government debt of just over $US30 trillion and a current ceiling of $US31.4 trillion the Biden administration will hit the ceiling by mid-year, if not before.

Rising interest rates, the forgiving of student loans, the cost of military assistance to Ukraine and the potential for higher social welfare spending if the economy shifts towards recession could bring that moment forward.

There has been brinkmanship over the debt ceiling in the past, generally brought on by Republicans who have seen it as leverage to force Democrat administrations into unpopular spending cuts rather than wear the political odium of making the cuts themselves. (The Trump administration increased government debt by far more – about $US7.8 trillion – in one term than the Biden administration’s $US3.5 trillion in its first two years).

The most recent instance of the debt ceiling being used as leverage for cuts to spending was in 2021, when the Biden administration went within days of running out of funding.

With the US Treasury already operating under “extraordinary” spending measures – suspending contributions to government pension plans, redeeming investments and deferring obligations – the government was on the brink of a default on its debts. Without a deal, the government would be unable to borrow or fund its agencies, pay its military or meet social welfare payments.

In the end, the Democrats were able to use a one-off process to circumvent the super-majority hurdle in the Senate and win a simple majority vote to raise the ceiling.

The more telling precedent, however, was probably a similar stand-off in 2011 when the US got so close to a default that Standard & Poor’s downgraded its credit rating. Barack Obama was forced to agree to $US2.5 trillion of spending cuts over a decade to avert disaster. S&P hasn’t reinstated America’s AAA rating.

The 2021 episode followed the more familiar pattern, with the Republicans wringing maximum political mileage out of the debates about debts and deficits that the debt ceiling deadlines allow before caving in at five minutes to midnight. The ceiling has been agreed more than 100 times since the Second World War.

The situation today is potentially even more incendiary than in 2011, when it was the fiscal hardliners in the “Tea Party” driving the Republican position.

Those who extracted the lengthy list of concessions from McCarthy (one, Matt Gaetz, said he had finally supported McCarthy because he had run out of things to ask for) include an odd mix of Trumpist “MAGA” conservatives and the successors to the Tea Party, the House Freedom Caucus.

Among their demands in return for raising the debt ceiling is a reprise of the 2011 deal.

They want substantial cuts to spending, indeed, there are those who want to impose a legislated budget pathway to a balanced budget within a decade that would probably require more than $US1 trillion of annual reductions in government spending, including swingeing cuts to defence spending, Medicare and other social welfare programs.

The Democrats’ left wing will never agree to big cuts to social spending, regardless of the consequences.

With the Biden administration adamant that it will resist what its spokesperson has described as “hostage taking” but McCarthy himself hostage to the minority of dissidents in his party that had blocked his elevation 14 times – he agreed to a provision that a single member of the House can force a vote to oust him, where previously the vote could only have been called by the party’s leadership – the potential for something catastrophic is probably greater than in previous debt ceiling confrontations.

A failure to lift the ceiling and a default on US government debt would be catastrophic.

Moody’s Analytics has estimated that a default would cause a 4 per cent cut to US GDP, an unemployment rate of 9 per cent (it’s currently about 3.5 per cent) and a $US15 trillion hit to household wealth.

Those are the direct domestic impacts. With trillions of dollars of US government debt held by foreigners, mainly by Asian economies with surplus savings – Japan holds more than $US1 trillion and China just under $US1 trillion – a default would have global repercussions.

The Democrats’ left wing will never agree to big cuts to social spending, regardless of the consequences.

The prospect of an imminent default would see an exodus of foreign bondholders and prospective buyers of Treasuries, causing carnage in the US bond market and plunging the US dollar into meltdown.

America’s “exorbitant privilege” – its ability to borrow relatively cheaply, avoid balance of payments crises and act as the world’s financial safe haven during outbreaks of global financial stress because of the dollar’s status as the world’s reserve currency – could be lost, or certainly significantly impaired.

That would play into the hands of others, like China, Russia and even the Europeans, who would like to see the power of the dollar and its potential to be weaponised (as it has been in sanctions against Russia and China and their companies and citizens) greatly diminished.

Sharemarkets would fall and interest rates would rise to reflect the heightened risks and uncertainties generated by a US default.

Even the imminent threat of a default would generate volatility in a year where there are already so many uncertainties like the war in Ukraine, China’s re-opening, the energy market stresses, global inflation and interest rates and the prospect of a global recession.

Hopefully sanity, while a dubious quality in some sections of the Republican Party and MAGA-aligned members of the House in particular, will prevail as it has in the past. The alternative is chaos, destruction, distress for the less-wealthy Americans and a greatly weakened America.

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