How the US Debt Ceiling Crisis Could Affect your Finances

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If you've ever used a credit card, you're likely aware that there is a cap on the amount you may spend. Your credit limit serves as a check on how much money you can spend and still afford to pay back. The amount of borrowing that the US government can use to fund its spending is similarly capped. Congress sets this ceiling, which is known as the debt ceiling.

The debt ceiling sets a cap on the amount of money that can be borrowed by the government to cover its existing obligations rather than how much money it is allowed to spend. Defense, healthcare, education, social security, and debt interest are just a few of the programs and services that the government spends money on. Taxes and other types of revenue, such as fees and tariffs, are two ways that the government is able to raise money.

Budget deficits can occasionally occur when the government spends more than it takes in. The government issues bonds and other instruments to raise money to pay down this deficit. Investors who loan money to the government in exchange for interest payments—banks, businesses, foreign governments, and private citizens—purchase these securities.

The government's borrowing capacity through the issuance of these securities is limited by the debt ceiling. The debt ceiling permits the government to pay for its prior expenditures but does not approve further spending. In US history, there have been numerous occasions when the debt ceiling has been lifted or suspended, typically without much discussion. The debt ceiling has, however, evolved into a source of political contention and ambiguity in recent years.

Why does Congress have to raise or suspend the debt ceiling periodically?

The majority of the US government's history has been marked by budget deficits, with the exception of a brief period in the late 1990s and early 2000s. The government's debt has risen over time as a result of borrowing more money than it has been able to repay. The US had a total public debt of nearly $28 trillion as of May 2021, which is almost 128% of its GDP (GDP).

The debt ceiling was first established in 1917 to make borrowing money easier by providing Congress with a single cap rather than requiring approval for each individual bond issue. In order to handle the rising debt since then, Congress has raised or suspended the debt ceiling around 100 times. The debt ceiling was last lifted by Congress in August 2019 when it decided to postpone it until July 31, 2021.

By this date, the government will have reached its borrowing capacity and won't be able to continue issuing new securities to fund its spending unless Congress raises or suspends the debt ceiling. This does not imply that the government will stop spending money, only that it will have to rely on its current funds as well as new sources of income to cover its expenses. Yet, particularly during times of excessive spending or low revenue, these sources could not be sufficient to meet all of its obligations.

What is the current situation?

On January 19, 2023, the US reached its debt ceiling and has since had to take exceptional steps to continue making payments. These actions include redeeming current treasury securities, delaying payments to state and local governments, and halting investments in federal retirement accounts.

These actions, however, fall short of closing the $300 billion monthly budget imbalance that the government faces. If Congress doesn't raise or suspend the debt ceiling, these safeguards will expire on June 1, 2023, according to Treasury Secretary Janet Yellen.

What are the risks?

The US will experience a historic default on June 1, 2023, which could lead to a financial disaster and harm millions of people if nothing is done. A default would imply that the government would be unable to make all of its scheduled payments, including interest on its debt, and this may lead to investors losing faith in US Treasury securities, the safest and most liquid assets in the entire world.

The government will have to give some payments more priority than others or postpone other payments until it has enough money to pay all of its debts if it runs out of money. As a result, the federal government would be unable to fulfill some of its responsibilities, including paying interest on its debt, paying staff salaries, providing benefits to veterans and retirees, giving grants to state and local governments, and refunding taxpayers.

Defaulting on any of these obligations would have severe consequences for the US and the global economy. For example:

• Defaulting on interest payments on the debt would damage the credibility and reputation of the US as a borrower and a lender. Investors would then lose faith in US securities and demand higher interest rates in order to lend money to the government or sell their current holdings at lower prices as a result. As a result, the cost of borrowing for the government would grow, and its capacity to finance spending would decline.
• Defaulting on salaries for federal employees would reduce their income and purchasing power, affecting their ability to pay their bills and support their families. Also, this would lower their morale and productivity, which would harm their performance and level of service.
• Defaulting benefits for veterans and retirees would harm their well-being and dignity, especially for those who depend on these payments as their main source of income. As a result, they would consume less and save less, which would affect how much they contributed to the economy.
• Defaulting on grants for states and local governments would force them to cut back on their own spending or raise taxes to make up for the lost revenue. They would no longer be able to offer basic services including infrastructure, health care, education, and public safety.
• Defaulting contracts for goods and services would hurt businesses relying on government contracts as a source of income and employment. Their operations and supply chains would be disrupted, which would have an impact on the delivery and quality of goods and services.
• Defaulting on refunds for taxpayers would delay or deny them their rightful claims for their overpaid taxes. This would limit their ability to make savings and investment decisions since they would have less money available.

All of these consequences would be detrimental to national security, trade, employment, inflation, consumer and corporate confidence, financial stability, and economic growth.

In addition, they might start a domino effect where one default follows another, leading to a vicious cycle of economic hardship and social unrest. Several analysts have cautioned that going into default on the debt could result in a depression or a financial crisis on a global scale worse than the one in 2008.

How can the situation be resolved?

The debt ceiling must be raised or suspended by Congress before June 1, 2023, as this is the only option to avert a default. Yet, to do this requires cross-party cooperation, which has been missing lately. Democrats have advocated that the debt ceiling should be lifted without conditions, while Republicans have demanded spending reductions or other policy concessions in exchange for raising the debt ceiling.

Over the past two years, President Joe Biden and House Minority Leader Kevin McCarthy have been attempting to reach an agreement to extend the debt ceiling while curbing expenditure on non-defense discretionary programs. A clawback of unused Covid-19 relief payments and other adjustments to federal food and healthcare programs are also part of the agreement. By May 31, 2023, a vote on the agreement is anticipated.

Congress respecting its existing commitments, not approving new spending, is what raising or suspending the debt ceiling signifies. The fact that Congress is avoiding a bigger problem—defaulting on the nation's debt—does not imply that it is ignoring the issue of mounting debt.

Congress can still address the problem of fiscal sustainability by implementing measures that over time lower the budget deficit and stabilize the debt-to-GDP ratio. These actions could be a combination of revenue increases, spending cuts, entitlement program reforms, and tax increases.

These measures, however, call for political agreement and long-term planning, both of which Congress frequently lacks. Thus, it's common to think that raising or suspending the debt ceiling is a better alternative than changing fiscal policy.

How could this affect your personal finances?

The US debt ceiling is a hot topic these days, as the government faces the risk of defaulting on its obligations if Congress does not raise or suspend the limit by June 1. But what does this mean for you and your personal finances? Here are some possible ways that the current US debt ceiling situation could affect you:

• You might have to pay more for borrowing, saving, and investing if the US declares bankruptcy. Mortgage, auto, credit card, and student loan interest rates may increase as lenders seek greater compensation for the increased risk of lending to the US government and consumers. As interest rates decline on secure assets like Treasury securities, savings accounts, certificates of deposit, and money market funds may offer reduced yields. When investors panic and dump their holdings of US and international assets, the stock and bond markets may endure volatility and losses.
• You can potentially experience decreased income and fewer government benefits if the US declares bankruptcy. If you work for the federal government or a contractor that depends on federal funds, your paycheck can be decreased or delayed. If the government is unable to pay for your Social Security, Medicare, Medicaid, or other benefits, they may be reduced or terminated. If the Treasury runs out of money, your tax refunds, stimulus cheques, and other government payments can be postponed or canceled.
• The debt ceiling agreement that President Biden and House Speaker McCarthy reached may still have an impact on you even if the US does not go into default. The agreement would keep the debt ceiling suspended until January 2025, but it would also cap non-defense discretionary expenditure in 2024 at current levels and only rise by 1% in 2025. Less money for initiatives that benefit you and your neighborhood, such as infrastructure, research, and education, could result from this. Also, the agreement would increase Pentagon spending by 11%, recoup unused Covid-19 relief payments, reduce funding for the CDC's global health program, and impose harsher work restrictions on low-income Americans who get food and medical aid.

The US debt ceiling is a sensitive topic for many people, not just politicians. It has an impact on the amount of money that the government must spend on its commitments and priorities, which in turn has an impact on the amount of money that you must spend on yours. You should be aware of the debt ceiling scenario and how it may affect your financial security whether you are a borrower, saver, investor, employee, beneficiary, or taxpayer.