Explained: What is the US debt ceiling deal and why it's important?

By Jason Lange

The US is rapidly approaching the deadline for Congress to pass a deal, reached over the weekend by Democratic President Joe Biden and top congressional Republican Kevin McCarthy, to suspend the government's $31.4 trillion debt ceiling or risk a catastrophic default.

When was the debt ceiling reached?

Washington regularly sets a limit on federal borrowing.

Currently, the ceiling is roughly equal to 120% of the country's annual economic output. The debt reached that ceiling in January and the Treasury Department has kept obligations just within the limit by suspending investments in some federal pension funds while continuing to borrow from investors.

 

The Treasury on Friday warned that it could run out of room under the limit as soon as June 5, a few days later than its earlier June 1 forecast.

Because the Treasury borrows close to 20 cents for every dollar it spends, Washington at that point would start missing payments owed to lenders, citizens or both.

Is the debt ceiling good for anything?

Few counties in the world have debt ceiling laws and Washington's periodic lifting of the borrowing limit merely allows it to pay for spending Congress has already authorised.

Treasury Secretary Janet Yellen and other policy experts have called on Washington to eliminate the limit, because it amounts to a bureaucratic stamp on decisions already made.

Some analysts have proposed that the Treasury can bypass the crisis by minting a multitrillion-dollar platinum coin and putting it in the government's account, an idea widely seen as an outlandish gimmick. Others argue the debt ceiling itself violates the U.S. Constitution. But if the Biden administration invoked that argument, which involves the 14th Amendment, a legal challenge would follow.

The White House has dismissed both ideas as impracticable at this stage.

What happens when Washington can no longer borrow money?

Shockwaves would ripple through global financial markets as investors questioned the value of US bonds, which are seen as among the safest investments and serve as building blocks for the world's financial system.

The US economy would almost certainly fall into a recession if the government was forced to miss payments on things like soldiers' salaries or Social Security benefits for the elderly. Economists expect that millions of Americans would lose their jobs. Ratings agencies have warned they could downgrade the US's sovereign credit rating -- as occurred in a prior 2011 showdown -- and investors have shunned some US debt securities that come due in the coming weeks as they try to avoid bills maturing when the risk of a debt default is highest.

How did we get here?

Republicans, who hold a narrow 222-213 majority in the House of Representatives, in late April passed a bill that would raise the debt limit but also set in place sweeping spending cuts over the next decade.

The bill has no chance of approval in the Democratic-controlled U.S. Senate. McCarthy and Biden over the weekend agreed on a tentative deal to suspend the borrowing limit for two years and cap spending, but they face objections from the most partisan lawmakers in each party.

Haven't we heard this song before?

This kind of brinkmanship has been part of US politics for decades but worsened significantly after fiscal hawks in the Republican Party grew in power since 2010.

In a 2011 showdown, House Republicans successfully used the debt ceiling to extract sharp limits on discretionary spending from Democratic President Barack Obama.

Spending caps stayed in place for most of the rest of the decade, but the episode rattled investors and led to a historic downgrade of the US credit rating.