It would be disastrous for the American economy, for global financial markets, and millions of families and workers,” a statement was given by U.S treasury secretary Jannet Yellen.
The treasury secretary warned the federal government to look over the catastrophic future of the economy as it is predicted that the treasury won’t be able to continue clearing the finances of the state after 18th October 2021. This certainly indicates that the world’s largest economy is on the way to be pushed through default in payments.
The present situation in the U.S economy
Not surprisingly the statement from treasury has its significance as the US economy stands at a debt of $28T with a GDP of $21T. Gross federal debt in the United States increased to 107.60 percent of the GDP in 2020 from 106.90 percent in 2019, according to estimates from the Office of Management and Budget. Increasing debt is viable to a certain level of commitment to support the economy and exceeding the limits can surely imply highly volatile recession chances.
The pandemic has led to increasing in government expenditure burden for social security and therefore increasing the debt cycle percentage. Borrowing to finance government expenditure has bound the treasury to pay large amounts and therefore pressure is built to support economic growth with stability in finances. The federal government debt is organized with citizens, own social security funds, foreign ventures as well own banks. The public holds over $21 trillion, or almost 78%, of the national debt.
After all the debt news, thinking why suddenly it is a problem?
Here it is, the US government have a debt ceiling of $28.5T, which is the upper limit of the treasury to take over debt for finances, the present day scenario indicates that the limit is approaching with current debt at $28.1T, which means the government is running out of money to pay the debts and other expenditures. With this the defaulting of the federal government to pay principal amounts, interest payments and provide for social security funds. To continue to pay out the same expenses the government would need to allow the debt to increase. that is remove the ceiling and let more debt pay off the current one.
The graph above shows how GDP was higher than the debt a decade back and slowly and gradually how the US government had increased the debt financing to a level more than its GDP. Spending over the pocket to a level where over the pocket expenses are not viable to achieve is a situation of a debt crisis, especially in the case of the largest economy which might affect the world with high voltage shots.
Question of the debt ceiling
What is the debt ceiling in the economy?
The debt ceiling is setting up an upper limit to the total outstanding public debt in any economy. This draws out a normal range of debt-financed government expenditure in contrast to economic growth and capabilities at the needed time. To prevent a debt crisis in economies due to excessive debt usage, this limit is set to bound the treasuries to operate with a certain percentage of the debt and the rest by revenue.
The US government used its debt fundings for providing relief packages and social security schemes to the population being exposed to pandemics. The unemployment benefits, food schemes, revving packages and decline in tax revenue due to pandemics had a significant impact on the treasury and therefore the treasury had no choice but to increase its dependence on debt.
This debt has now reached a point where it might touch the ceiling line. The treasury secretary exclaimed that the treasury was trying to delay the upcoming debt crisis for a couple of months by paying expenses through extraordinary means but they would require direct solutions now. These solutions can hit the economy too hard but to absorb the debt one of them is to be taken up. These solutions are given down.
One way is to increase the debt ceiling
Increasing the debt ceiling means shifting the upper limit for debt further upwards, allowing the treasury to add more debt to repay old debts and obligations. This will save the short-term default of treasury and will continue to operate for all the expenses by adding up new expenses o new debt. this is going to be a vicious circle of debt and increase the debt burden on subsequent generations. This can be a short or medium-term benefit plan as it will keep the markets on the bearable side.
The thing that can be severely wrong is that behaving towards new debt would mean new issues of Treasury securities, and the cost of this would be an increase in money supply in the economy. the level of employment and absorption power of the economy is an indicator of how this increase in supply would bear with in-hand inflationary pressures.
The employment factor would be a direct impact of such change as it is already disturbed due to the pandemic effect. This simply means more unemployment would pressurize the treasury to increase allowances and therefore again a vicious circle of more expenditure.
As rightly said, no stabilization without shocks is possible. Therefore all of the therapy impacts would depend on household, investor and business sentiment and absorption capacity of the economy.
If the debt ceiling is kept intact
There is scope for the economy to work under immense pressure, thankful to the plan of 2011, The US economy faced the same situations and therefore a plan was given out. The treasury is expected to use the same plan if binding limits reach. The plan was rigorous and suggested a great deal of change in normal operations while keeping debt-related payments intact.
This plan explained to pay full interest payments on treasury securities with the due date and no defaults on the capital amount, the securities with matured dates would be paid out of auctioning new securities. This can be a saver for any new public debt creation and hence not increasing the burden.
However, in the basic economic language, when you pay one you have to reduce two to stay in your pocket. Unfortunately, without increasing more debt the government can either pay for interest and capital or other expenditures like social security schemes, old-age pensions, unemployment benefits and other contractual payment obligations.
When the treasury chooses the debt clearance it does it to stabilize the financial markets so that investors or the treasury market stays intact otherwise it will disturb the whole financial system.
On that note, it has to reduce its expenditure on the above-mentioned sources to the public, and have to default the payments to staff salaries, military salaries, other contractual projects. This will surely lead to legal boundaries and trust deteriorating situations but left with no options.
It is estimated that if the debt limit binds, the treasury would have to cut all the other expenses by nearly 40% to pay out normal interest and capital amounts. This number is not a small one, imaging the scenario where already pandemic has demoralized the growth and unemployment prevailing, with health expenditures being necessary, this cut of will have a severe impact on the public.
“Nearly 50 million seniors could stop receiving Social Security payments or see them delayed, our troops would not know when their paychecks would come. Thirty million families who rely on the Child Tax Credit would not receive them on time, unemployment would surely rise,” Janet Yellen said in her concluding statement.
Binding on debt can cause a high-level impact on financial markets as it all depends on investor sentiments if they trust the treasury to pay interest for a stabilized time or they do not acknowledge the measure and turn their ways. Finding buyers for securities will be more difficult in such cases, altogether making it a recession-like situation. Therefore this can be a short-term measure as all the other outlays are a part of the economy and even if the situation persists a bit longer the treasury would be forced to default on debt payment as well.
Finally of course with less debt financing and more expenditure, the government would be forced to shift the burden to taxpayers, creating more critical expenses.
Global impact of the retrospective crisis
Talking about global impact, this is very obvious that investors rely most on US markets as they are considered the safest. The default situations will create a mess around global financial markets as well as goods markets in the international set-up. The treasury market would be on a high note and will be a result of investor’s off-brand trust in the federal system which can result in crashes in stocks as well as a long term impacts long-term impact on FDI(foreign direct investment).
The immediate effect would be that there would be a bullish sell-off of treasuries and that would increase the interest rates, impacting present interest payments, future borrowing for government, and public borrowed loans that would completely change the dynamics.
Global trade in the short-run would be jeopardized and therefore countries exporting to the World’s Largest Economy (US) would face losses. Many countries use dollars as a medium of exchange and even for their local transactions, this event would lead to a decline in the value of the dollar, therefore, reducing credibility towards payments. The global markets would be hence affected by currency politics.
On an average analysis of the current situation, we can surely generate a perspective that the US economy would require highly volatile solutions and properly aimed at balancing the economy. whatever the congress decides, one thing is clear that the predictions and future commitments of the treasury are going to arrange changes in world economic status as the US being the largest economy affects the slab of growth for all.
