Debt ceiling negotiations over – Congress approval

Let’s start with the debt ceiling.  After weeks of negotiations, President Biden and House Speaker Kevin McCarthy struck a deal to suspend the debt ceiling until January 1, 2025.  That removes the possibility of the U.S. defaulting on its debt obligations, which would certainly have triggered a massive recession. 

Quick recap in case you haven’t been following this story very closely.  The debt ceiling is “the total amount of money that the United States government is authorized to borrow to meet its existing legal obligations.”1  What are these obligations? Think Social Security and Medicare benefits.  Military salaries.  Tax refunds and interest payments on Treasury bonds. 

The debt ceiling, then, is the limit to what the government can borrow to pay back what it has already spent.  (Or is legally obligated to spend.)

Normally, raising the debt ceiling requires a simple act of Congress.  Some years, however, politicians disagree on whether the ceiling should be raised without a simultaneous decrease in spending or other appropriations.  When this happens, we get a debt ceiling crisis, where the nation comes close to defaulting on its debts. 

In this case, Janet Yellen, the Secretary of the Treasury, predicted that the U.S. would default sometime in June if the debt ceiling wasn’t raised.  With that deadline in mind, the President and the Speaker reached an agreement on May 28.  A few days later, Congress approved the deal.

Here’s a brief look at what’s in the deal.  First, and most importantly, is the aforementioned suspension of the debt ceiling.  Rather than raising the ceiling to a new number, Washington has negated the idea of a debt limit altogether for the next eighteen months.  This means the government can borrow above the current limit in order to meet its existing obligations. 

In return, both sides of the political aisle have agreed to cap future domestic spending to 1% through the 2025 fiscal year.2  Given that this number is lower than inflation, this effectively amounts to a spending cut.  The deal also ends the White House’s pause on student loan payments, while adding new work requirements for Americans who qualify for food stamps and other government assistance. 

For the economy, however, the deal is less important for what it does than for what it prevents. 

If the U.S. had breached the ceiling and defaulted on its debt payments, the economic impact would have been severe.  Seniors would have stopped receiving Social Security payments, or at least experienced delays.  Child Tax Credit payments, paychecks for federal employees, veterans’ benefits, Medicare benefits…all would have been either curtailed or delayed. 

Less gut-wrenching on a human level, but equally impactful financially, is what a default would have meant for the bond market.  In a default, bondholders would no longer have been paid.  The value of their bonds would have plummeted.  This would have led to dramatically higher interest rates on any new debt issued in the future – which in turn would mean higher rates for everyone.  Given that rates are already higher than they’ve been in years, this would have likely plunged the economy into a deep recession.  And since Treasury bonds are historically the most stable investment in the world, it would probably have disrupted international bond markets, too.  The result?  A global recession. 

Thankfully, the debt ceiling deal prevented this crisis from unfolding.  And while politicians on both sides of the aisle are reportedly unhappy with some aspects of the bill, the risk of default was simply too great.