The game of chicken over the US debt ceiling has begun

It’s D-Day in America. Actually, it’s not quite there yet, but the fuse is now burning towards it after the US government probably hits its debt ceiling overnight.

US Treasury Secretary Janet Yellen warned Congress last week that the government was projected to reach the statutory limit of $US31.381 trillion ($45.2 trillion) this Thursday US time, and would then need to start taking “extraordinary measures to prevent the United States from defaulting on its obligations.”

Failure to meet those obligations – a default on its debts – would “cause irreparable harm to the US economy, the livelihoods of all Americans and global financial stability,” she said.

US Treasury Secretary Janet Yellen warns that a debt default would “cause irreparable harm to the US economy, the livelihoods of all Americans and global financial stability”,
US Treasury Secretary Janet Yellen warns that a debt default would “cause irreparable harm to the US economy, the livelihoods of all Americans and global financial stability”,Credit:afr

Her best estimate of how long Treasury could continue to operate with extraordinary measures, which she said would start with the redemption of existing investments and the suspension of new investments in a number of federal government investment, health and pension funds, was as early as June.

An actual default on the federal government’s debt would be catastrophic for the US economy and financial markets and potentially trigger a global financial panic, threatening the US bond market’s status as the world’s safe haven and the US dollar’s status as the world’s reserve currency.

Already there are kinks appearing in the US Treasuries markets around what’s referred to as the “X-date,” or the moment the US Treasury exhausts its extraordinary measures and runs out of cash. Yields on six-month Treasury bills maturing mid-year have spiked and issues of new bills maturing around that period are being shunned.

While there have been regulator bouts of brinkmanship around the debt ceiling in the past, a default has always been averted.

Disaster was only narrowly averted in 2011 when Barack Obama was forced to agree to significant spending cuts in return for an increase to the debt ceiling. That episode went so close to the brink that the US lost its AAA credit rating from Standard & Poor’s.


The new Republican majority in the House and the power that the Trumpist “MAGA” and ultra-conservative House Freedom Caucus factions demonstrated in forcing new Speaker Kevin McCarthy to agree to an exhaustive list of concessions as the price of their support for his elevation to that position, including a commitment to support deep cuts to government spending, has significantly increased the risk of a default.

The Biden administration is adamant that it won’t negotiate on major spending cuts. It would say that, but politics in the US is so polarised, and some of those within the narrow Republican majority in the House so extreme, that it is conceivable the Republican demands will be so unpalatable that the White House will never agree to them.

‘Financial Armageddon’

There are those in the party who want to demand a legislated balanced budget within a decade in return for an increase in the debt ceiling, which would force massive multi-trillion dollar cuts to government spending on defence, medicare and social security, among other programs.

Moody’s Analytics has estimated that a default (which is says would be “financial Armageddon”) would cost up to six million jobs in the US and as much as $US15 trillion of household wealth. But the flow-on effects, in the US and globally, are incalculable.

The thin liquidity in bond markets, including the US market, could lead to a seizure of the financial system akin to that which occurred in March 2020 at the onset of the panic. It took unprecedented actions by the Federal Reserve Board to avert a meltdown of the US system then.

(Ironically, Treasury’s inability to issue new debt should add to liquidity and offset the Fed’s “quantitative tightening”, or its $US95 billion-a-month of balance sheet shrinkage.)

McCarthy agreed to the demands of his conservative factions that the vote of one member of the House could trigger a vote to remove him as speaker. That he was prepared to concede so much to attain the position suggests he won’t agree to put forward any compromise that those factions don’t support.

That has led to discussions about workarounds that would enable the White House to circumvent the conservatives and even Congress.

There have been discussions between Democrats and moderate Republicans about a less ambitious/radical deal. It only takes six Republicans to support a compromise deal for it to clear the House.

There’s been some talk about the use of a rarely-used process known as a discharge petition, under which a bill can be taken out of the committee process (where the Republicans could otherwise keep it until a default occurred) and moved to the floor of the House for a vote. It would take 218 votes, a majority of the House, for that to occur.

But this is regarded as a difficult and time-consuming process. It takes 30 legislative days, which translates to as many as three calendar months, before it can be brought to the floor of the House.

Also, Republican moderates would want something significant in exchange for their support and the ire that it would attract from other Republicans and their supporters, so it would still involve concessions on spending that the Biden administration is adamant it won’t make.

An intriguing, and radical, idea that has been floated in the past and researched by the Obama White House and the Fed in the past has resurfaced.

There is nothing to prevent the US Treasury from minting a “platinum” or trillion-dollar coin and depositing it with the Fed, which would then credit the Treasury’s account with $US1 trillion. Debt ceiling solved.

Yellen, however, has described the concept as a gimmick, the Fed’s Jerome Powell hates the idea and might refuse to accept the coin, and there is also no guarantee that – even if accepted by the Fed – a measure so obviously borne from desperation and political dysfunction wouldn’t ignite a similar fallout as a default.

As the days and months go by and the X-date looms, markets are going to take the prospect of an actual default by the US increasingly seriously. The process will clearly go to the brink, or even beyond.

The game of chicken that politicians in the US will play out over the next few months will have consequences, potentially profound, and not just for the US.

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