Debt ceiling: Here’s what could happen in the event of a credit “debacle”

The federal government’s cap on the amount it can borrow to finance itself is fast approaching. US Treasury Secretary Janet Yellen told lawmakers last week that the nation would reach the debt limit on Jan. 19, prompting a flurry of warnings from Wall Street analysts and economists about the potential financial consequences if Congress fails to act.

The debt ceiling currently stands at $31.4 trillion, which is the amount borrowed by the Treasury Department to finance its financial obligations, from insurance benefits like Social Security benefits to interest on the national debt.

Yellen urged congressional leaders to raise the debt limit set by lawmakers as soon as possible to avoid a financial crisis. But with a Republican-controlled House of Representatives, it’s unclear whether lawmakers can reach a compromise to raise the ceiling. If lawmakers fail to reach an agreement, “the debt limit risks a self-inflicted recession,” Gregory Dako, chief economist at EY Parthenon, said in a report.

Failure to raise the debt ceiling could lead to a “real disaster,” David Kelly, chief global strategist at JPMorgan Funds, told investors in a note to clients.

But some skeptics say the U.S. has options to avert an economic disaster, such as the possibility that the Treasury could even mint a platinum coin that could be transferred to the Federal Reserve and used to meet its financial obligations.

Here’s what you need to know about the debt limit and its potential impact on the economy.

What is the debt limit?

The debt limit, set by Congress, is the maximum amount the federal government can borrow to pay its debts.

If the amount of national debt reaches this threshold and does not clear the ceiling, the US will not be able to pay its debt and could default.

It’s important to note that when Congress raises or suspends the debt ceiling, it does not give the green light to new spending. Instead, it gives the go-ahead to the Treasury to pay for spending that has already been approved.

Has the debt limit been raised before?

yes. Since 1960, Congress has acted 78 times to raise, temporarily extend, or revise the debt ceiling. respectively to the treasury.

Of these, the debt limit changed 49 times under Republican presidents and 29 times under Democratic Party administrations, the Treasury Department said.

The last time the debt ceiling was lifted was in December 2021, when Democrats controlled both the House and Senate.

What happens if the debt limit is not raised?

As the U.S. approaches the debt ceiling on Thursday, the Treasury Department will take several steps to ensure it continues to pay the government’s bills.

“These special accounting measures should provide the Treasury with about $400 billion in additional borrowing capacity under the debt ceiling,” EY Parthenon’s Daco said in a note.

But without action from Congress, the US could face default on its debts as early as June, Yellen warned last week.

What does “Date X” mean?

“X-Date” — or “X-Date” as it’s sometimes called — is the day when the U.S. government will be unable to meet its financial obligations, a point that will likely have “catastrophic consequences for financial markets and Americans across the country.” respectively to the Center for Bipartisan Politics.

For now, Yellen puts the X date in June, but other estimates vary. The bottom line, however, is that the US could be months away from default unless the debt limit is raised.

“X’s debt limit date is a moving target,” Benjamin Salisbury of Height Securities noted in a research note. “Yellen’s prediction that a default could come as early as June is several months ahead of previous forecasts that put the date around August.”

What happens if the US defaults?

According to some economists, if the U.S. reaches a date when it can no longer pay interest on the trillions it already owes and defaults — something that has never happened in the country’s history — the result could be catastrophic.

Because U.S. debt is considered the backbone of the global financial system, in part because of its stability, a default could shake economies around the world. Americans may also face a recession, including rising unemployment, as well as the stock and bond markets most likely to take a dip, destroying trillions in wealth. Recipients of federal benefits, such as Social Security recipients, may not receive monthly checks.

But what about mandatory costs?

This is where some critics disagree with the doomsday scenario, as economist James C. Galbraith writes Project Syndicate that Social Security, Medicare, Medicaid, and interest payments are mandatory expenses – essentially, the US is required by law to pay for these benefits.

“The US Treasury must follow the law. Debt limit or not, it cannot legally default on any obligations,” he noted.

He added, “[T]The Treasury has no legal authority to single out social security, interest payments or anything else for cuts, and as far as I know it could not stop those payments if it wanted to.’

In its nearly 100-year history, Social Security has never failed to make a payment, Galbraith said.

Can the US avoid default without raising the debt limit?

The Treasury and lawmakers have some options that could help the U.S. meet its financial obligations and avoid default, economists say.

First, the Treasury has the right to mint platinum coins of any denomination. In theory, Yellen could issue a $1 trillion platinum coin and deposit it into the Fed so that the coin can be used to service its debt obligations. The idea of ​​a trillion coin, however, was – hit Elena in the past.

Dako also echoed Galbraith’s argument, noting that the constitutionality of the debt limit could be challenged because the 14th Amendment states that “the validity of the public debt of the United States, authorized by law, […] will not be questioned.” But, Dako added, “it was rejected by previous administrations.”

And there is the possibility of a procedure called a “relief petition” in Congress to lift the debt limit, Dako added.

This “will bypass the need for approval of the committee chairman, as well as the speaker, who will be presented for a vote, which will allow moderate Republicans of the House of Representatives to join the Democrats in raising the debt limit,” he noted. “This procedure, however, would take more than a month, and thus would not be a last-minute option.”