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America Seems Headed for a Debt Ceiling Showdown

Joe Biden
Joe Biden's State of the Union Address in 2021.

There is never a good time for a protracted fight over raising the US government debt ceiling. However, today would seem to be a particularly bad time for such a fight. Not only do the US and world economies appear to be on the cusp of recession. US and world financial markets appear to be especially vulnerable to a major loss of risk appetite that fears about a possible default by the world’s largest government debtor would almost certainly involve.

There can be little doubt that we now appear to be heading towards a major debt ceiling fight by early this summer. In a letter to House Speaker McCarthy, Secretary Treasury Janet Yellen indicated that the US government has now reached its debt ceiling limit. She also indicated that the Treasury will be taking “extraordinary measures” that should allow the government to avoid a debt default at least until early June.

Making a protracted debt ceiling fight all the more likely is the large gap between the Republican House Majority and the Biden Administration’s opening positions over this issue. Mr. McCarthy, who is beholden to the Freedom Caucus of the Republican Party, keeps repeating that he will not agree to raising the debt ceiling without a commitment to large public spending cuts, including on Social Security and Medicare spending. He does so, knowing full well that such spending cuts are anathema to President Biden.

For his part, Mr. Biden believes that the debt ceiling should be raised without any conditions being attached since Congress had already approved the underlying spending.

A number of times in the past, when there have been large political differences over an important economic issue, entrenched political positions only changed when politicians found themselves staring over an economic abyss. This happened in 2008 over the introduction of the Troubled Asset Relief Program (TARP), which was only passed once there was a major stock market and credit market meltdown.

This would make it likely that today’s debt ceiling negotiation too will only be resolved when financial market dislocations force politicians to come to the table for fear of being blamed for inviting a deep economic recession.

In 2011, when last a debt ceiling negotiation went down to the line, US and world financial markets were roiled even though in the event a debt default was avoided. Markets were deeply troubled by the prospect that the world’s largest sovereign borrower might default on its debt obligations. Following that episode, Standard and Poor’s deprived the US government of its coveted AAA rating, which had the effect of raising the government’s borrowing costs.

Today, there is reason to believe that should the debt ceiling negotiations again go down to the wire, US and world financial market turmoil would be worse than in it was 2011. The last thing that financial markets now need are doubts about whether the US government will meet its debt obligations at a time when the world is drowning in debt and when the stock market and housing markets are already being roiled by the most rapid monetary policy tightening in the past forty years.

All of this suggests that now is certainly not the right time to be playing political games with the debt ceiling issue. By inviting financial market turmoil, such games could put a soft US economic landing out of the Federal Reserve’s reach.

We have to hope that politicians soon recognize the real economic risks of another bruising debt ceiling fight. Maybe then they would find a way to bridge the presently large gulf between their respective negotiating positions.

However, given the very narrow House majority and given how beholden both sides are to the more extreme flanks in their parties, I would not suggest betting on an early resolution of this issue.

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Dr. Desmond Lachman is a senior fellow at the American Enterprise Institute. He was formerly a deputy director in the International Monetary Fund’s Policy Development and Review Department and the chief emerging market economic strategist at Salomon Smith Barney.

Written By

Desmond Lachman joined AEI after serving as a managing director and chief emerging market economic strategist at Salomon Smith Barney. He previously served as deputy director in the International Monetary Fund’s (IMF) Policy Development and Review Department and was active in staff formulation of IMF policies. Mr. Lachman has written extensively on the global economic crisis, the U.S. housing market bust, the U.S. dollar, and the strains in the euro area. At AEI, Mr. Lachman is focused on the global macroeconomy, global currency issues, and multilateral lending agencies.

5 Comments

5 Comments

  1. John

    January 19, 2023 at 4:27 pm

    the GOP has become unelectable. The party of Reagan is no more.

  2. 403Forbidden

    January 19, 2023 at 4:57 pm

    It’s no surprise that america is getting into a coming unavoidable financial Armageddon due to Joe Biden wanting to stoke war and tension around the world, particularly in Europe.

    Biden is the latest antichrist from the good old USA, the devil in the flesh, or more specifically, the chief of 😈 deviousness.

    Biden is spending money like there’s no tomorrow, or money is becoming out of date, inspired by his mentor, xi jinping of china.

    The US supreme court must issue an immediate arrest warrant for both criminals and put them away for good.

    Down with Joe Biden.

  3. Jim Higgins

    January 20, 2023 at 9:06 am

    Dementia Joe spends with wild abandon. THe GOP should initiate a default-the shock should make the government realize that they do NOT have an unlimited checkbook!

  4. GhostTomahawk

    January 23, 2023 at 2:02 pm

    God forbid our govt show some fiscal responsibility. We don’t need a 6 trillion dollar budget. Since covid the Govt is stuck on running deficit spending. We need a budget. We need the budget to not include debt. Honestly the 9+ million federal employees (not counting the contractors) are not helping

    Figure it out or don’t get paid.

  5. ross

    January 23, 2023 at 3:36 pm

    Over 70% of the federal budget goes to Social Security, Medicare, Medicaid, and the DOD. Until those items are dealt with, meaning reduced benefits, this problem is not going away. Talk about government employees, aid to Ukrain, the IRS, government waste and corruption, etc etc won’t make a dent in the debt. Social Security, Medicare, and Medicaid are the drivers of the debt and nothing else.

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