US Debt Ceiling: How Default Could Affect You

What is the US debt ceiling and why does it matter?

The United States Congress first introduced the debt ceiling — the upper limit of money that the government could borrow — in 1917. The measure meant the government no longer needed approval from lawmakers over every debt issued. The Public Debt Acts were subsequently passed in 1939 and 1941.

Over the past seven decades, the debt ceiling has been raised a whopping 78 times, including in 2011 when the delay in agreeing to a new limit resulted in the US losing its coveted AAA credit rating, sparking an increase in borrowing costs.

The current debt limit of $31.4 trillion (€28.6 trillion) was reached in January but the Treasury Department took extraordinary measures to allow it to continue financing the government's activities.

The next key deadline of early June fast approaches, by which time Congress must once again raise the ceiling, or the US government could begin to run out of money and default on its debt.

A fierce standoff is underway between the Democrats and Republicans, who want the White House to agree to sweeping public spending cuts as well as other reforms.

Top Republican leaders met US President Joe Biden on Tuesday at the White House to try to resolve the dispute, but the talks broke up without a major breakthrough.

A debt default by the world's largest economy would likely cause a global recessionImage: YAY Images/imago images

How would a debt default impact the global economy?

US Treasury Secretary Janet Yellen warned Sunday that the standoff was effectively a "gun to the head of the American people and the American economy."

She said that "financial and economic chaos would ensue" from any failure to raise the debt ceiling.

Last week, the Treasury Department predicted that the US government would begin to run out of funds as early as June 1 — a move that would have far-reaching consequences for the US and global economy.

The lack of funds would force the US Treasury to likely prioritize spending so that debt payments and interest payments are made first.

That could mean delays to the payment of salaries of tens of millions of public sector workers, including teachers.

Social security payments and healthcare subsidies to older and vulnerable Americans, including military veterans, could also be put on hold.

Although any debt non-payment would likely be temporary, an analysis by Biden's economic advisers has warned that even a "brief" default would cost the US economy 500,000 jobs.

They believe a "protracted" default would send GDP plunging by 6% with the loss of tens of thousands of businesses and some 8.3 million jobs — almost as many as during the 2008 financial crisis.

In a worst-case scenario, the US would have to stop borrowing altogether by July or August, which would send further shockwaves through global financial markets.

Investors would then question the value of US bonds, which are seen as among the safest investments and serve as building blocks for the world's financial system.

A default could severely weaken global trade and tip the rest of the world into a deep recession.

A more serious default would cause a sharp decline in the US dollar, causing chaotic fluctuations in exchange rates, and spiking the prices of oil and other commodities. 

Global inflation may well rise again and supply chain issues, which dampened trade following the COVID-19 pandemic, could worsen due to the lack of trust within the financial system.

House of Representatives Speaker Kevin McCarthy met Biden on Tuesday but the two sides failed to break the deadlock over the debt ceilingImage: Kevin Lamarque/REUTERS

What are the main sticking points?

House Speaker Kevin McCarthy and the Republican Party are refusing to hike the debt ceiling without sweeping budget cuts.

The Republican-led House voted in late April to cuts worth around $4.8 trillion in a proposed budget bill that would eliminate tax breaks for clean energy investments and reverse Biden's plan to forgive student loan debt.

However, the legislation has no chance of being adopted in the Senate, with its Democratic majority.

Biden has so far refused to negotiate, saying the debt ceiling should be raised without conditions, and then he will discuss possible budget cuts.

The US president wants the Republicans to make a public commitment that the US won't default and can keep paying all of its bills by having the ability to keep borrowing.

During Biden's tenure as vice president in 2011, the Obama administration was forced to make painful concessions to the Republicans in an effort to avoid default and the US president is keen to avoid a repeat of that climbdown.

Biden's budget plan would trim deficits by nearly $3 trillion over a decade, mainly through tax increases on the wealthy, which the Republicans are unlikely to agree to.

Following Tuesday's unsuccessful talks between Biden and senior Republican and Democrat leaders, McCarthy estimated that the two sides had as little as two weeks to reach a deal that could then be passed by Congress.

Some analysts, however, still think the expiration of the debt limit cold be delayed until September 30 to avoid the immediate risk of default.

What else could Biden do?

The president could, in theory, invoke the 14th Amendment of the US Constitution which states that the "validity of the public debt of the United States, authorized by law, ... shall not be questioned."

Some analysts believe Biden can argue that he has a constitutional duty to avoid default and thus can blow past the debt limit to continue the spending that Congress has already approved.

However, that move would almost certainly lead to prolonged legal wrangling, which could unsettle financial markets.

Republicans have warned that Biden cannot act unilaterally and that the solution has to come through Congress.

This week, a union of public sector workers sued Treasury Secretary Janet Yellen and Biden to make the argument that they are constitutionally obligated to disregard the debt limit.

The lawsuit is trying to ensure workers aren't penalized while debt payments are prioritized in the event of a default.

Edited by: Ashutosh Pandey