Monday, November 29, 2021

The Debt Ceiling: What It Means for the Economy and Markets

The White House announced Monday that the U.S. will reach its borrowing limit and will soon default on its obligations. On Wednesday, President Trump said he plans to sign a resolution to raise the debt ceiling, but how might he, Congress or the global markets react to this unprecedented event?

Why has there been no vote on a debt ceiling increase in Congress?

The congressional failure to raise the debt ceiling has been a longstanding fight between Republicans and Democrats, but this is the first time a Republican president has raised the debt ceiling without Congressional approval. That was Trump’s intent, and in fact, the administration had already submitted legislation to Congress to lift the debt ceiling on September 28, without a vote from the Hill.

The key event that came out of this delay was Trump’s recent tweet on September 26. After weeks of lobbying from many outside groups, including The President’s Committee on the Arts and Humanities and the U.S. Chamber of Commerce, Trump stated that he would not allow the government to default on its debt.

“We are not going to default,” Trump wrote on Twitter. “I will be announcing shortly what we are doing.”

Why are lawmakers debating the debt ceiling now?

The Treasury Department had warned Congress that the debt ceiling would be reached by mid-October, but the Department of the Treasury confirmed on Monday that the Treasury would not be able to pay all of the nation’s bills after the debt ceiling is reached. Congress was able to avoid a shutdown over funding the government, but now the government shutdown over the debt ceiling is a reality.

What would happen to the U.S. if there were a default?

If the debt ceiling was not raised, there would be a potential for a technical default and the possibility that the U.S. could lose its AAA credit rating. Still, the U.S. government would have little to no problem paying off its obligations if it had enough money to do so.

For investors, the defaulting on the debt would most likely be expected to move other countries to shift their investments to more conservative assets.

How would a technical default be handled?

Treasury would follow the same process it normally does when the debt ceiling is reached. While it does have about $188 billion in cash on hand, and $128 billion in cash from overseas investments, it could have trouble paying all of its obligations. As a result, Treasuries (and their U.S. government counterparts) would begin to decline in value, increasing interest rates. The dollar would also plunge, and the Fed would find that it was paying much more interest for Treasuries than it was saving from the negative impact of the increase in interest rates, leading to the eventual reduction of the interest rate on bonds and other assets.

What will happen to the federal budget?

Some lawmakers have called for the government to delay its spending and create a budget as a result of this standoff, but most experts believe that a government shutdown will not happen. Even a technical default will not have a major impact on government operations, and as a result, a budget standoff is unlikely to result in a shutdown.

How will the debt ceiling battle impact the markets?

The U.S. stock market was largely unaffected by the events leading up to the debt ceiling debate, with the Dow Jones industrial average ending Friday at 26,024.92, up 2.05 percent for the week. Investors appear to have taken the short-term events in stride, but even the slightest indication that the government will not pay its bills in full could cause significant damage to the market in the long term. It will be a key event to watch this week as tensions escalate between the White House and Congress.

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