US lawmakers have just weeks to come to an agreement to lift the limit on federal borrowing or risk financial calamity if the government can no longer meet its obligations.
After a two-year suspension, the debt ceiling is back at the centre of a high-stakes political battle that is only set to intensify as the window for a deal begins to close.
Here is a guide to what is going on, why it matters and what it will take to avoid a US sovereign debt crisis.
What is the debt ceiling and why is it an issue again?
The debt ceiling sets a limit on the amount that the Treasury department can borrow to pay government commitments already approved by Congress.
Once the ceiling is reached, US lawmakers must either increase or suspend it to allow for the agency to issue new debt and raise the necessary cash to cover its bills — something they have done almost 100 times since the end of the second world war.
It was last suspended in 2019 under the Trump administration, and on August 1 was reinstated at about $28.5tn, which includes all of the debt accrued since the previous suspension.
Once a routine affair, adjusting the debt limit is now often used as a political tool by Republicans to extract concessions on federal spending. The stand-offs, which have in the past brought the US dangerously close to default, have always ended in a resolution.
But tensions are rising again on Capitol Hill as the debt-ceiling deadline is colliding with Joe Biden’s efforts to pass his multitrillion-dollar economic agenda through Congress, rekindling fears that lawmakers will again push negotiations to the brink.
How long does Congress have left?
Janet Yellen, US Treasury secretary, warned last week that the Treasury may run out of cash next month. The Bipartisan Policy Center, meanwhile, has pencilled in mid-October to mid-November, with much depending on the highly uncertain trajectory of federal spending and revenues due to the pandemic.
Shai Akabas, director of economic policy at the Washington think-tank, said the Treasury had already used up most of the “extraordinary measures” or accounting manoeuvres it had available to buy time. These include pausing investments in certain federal retirement and health funds. The Treasury also has on hand about $400bn in cash.
Once those resources are exhausted, it will no longer be able to make good on obligations such as Medicare-related dues and veterans’ benefits. Interest payments on US government debt held by investors could also be interrupted.
What is at stake if the debt ceiling is not adjusted?
It is hard to overstate the economic, financial and political consequences of a US default. Yellen has warned of an immediate blow to business and consumer confidence, higher borrowing costs that could precipitate a global crisis and another hit to the country’s credit rating, which was downgraded in 2011 amid a previous debt-ceiling clash.
“A default by the US on its sovereign debt would really force people to think twice about the existing world economic order,” said James Lucier, managing director at Capital Alpha Partners in Washington. “The US is not Argentina . . . It is not an issue of the capacity to pay, it is the willingness to pay.”
The stakes are so high that Libby Cantrill, head of public policy at Pimco, said no political faction would dare risk a default.
“The downside is so great that conventional wisdom [suggests] that Congress will not impose this self-inflicted wound on the US economy, especially in the middle of a pandemic.”
How are financial markets reacting?
Wall Street is so far unfazed by the looming deadline.
“It feels like the movie we’ve all seen before and it is getting pretty old,” said Bret Barker, a portfolio manager at TCW. “This is something we see every two years and people are catching on that this is showmanship and political posturing.”
Treasury bills that mature in late October and early November are offering only minute concessions, signalling a very minor shift by money managers to protect against the possibility of a missed payment by the government.
In 2011 and 2013, the reaction was far more dramatic. Federal Reserve economists wrote in a 2017 paper that yields on all Treasuries rose between 0.04 and 0.08 percentage points ahead of the two debt ceiling impasses, before falling upon resolution.
However, they noted that by 2013, money managers had “learned from the 2011 debt limit impasse and its eventual resolution at the eleventh hour”. By that year, the biggest action was seen in the short-term bill market, a dynamic that could repeat as the deadline approaches.
Wall Street is also distracted by other problems, including decelerating economic growth and potential policy shifts by the US central bank.
“This is one more thing to worry about,” said Ashish Shah, co-chief investment officer of fixed income at Goldman Sachs Asset Management. But he added that “markets will look past this”.
“This is a time of such great uncertainty anyway and such substantial liquidity support that the market is not supposed to be putting too much weight on this as a risk.”
How could this be resolved?
Negotiations in Washington are at a standstill, and if anything, the rift has widened.
Republicans led by Mitch McConnell, the party leader in the Senate, say their lawmakers have no intention of raising the debt limit because it would amount to an endorsement of Biden’s spending plans. Republicans say Democrats should simply add a debt ceiling increase to their huge social safety net investment package, worth up to $3.5tn, which will pass only with Democratic votes.
But Nancy Pelosi, the Democratic speaker of the House, is insisting that there should be bipartisan support for raising the debt ceiling, since it reflects trillions of accumulated debt from measures approved by Republicans over the years.
Democrats are pushing Republicans to consider approving a debt-limit increase in other must-pass pieces of legislation, including a possible relief bill for natural disasters and aid to Afghan refugees, and a “continuing resolution” to keep funding the government after October 1.
If no agreement is reached on government funding, the US could face a shutdown of federal operations at the same time as a debt ceiling crisis, compounding the damage and disruption to the economy and markets.