On a wall in Manhattan, not far from Times Square, a clock indicating the US national debt now displays more than $31 trillion, more than 10 times higher than the $3 trillion it was when it was installed in 1989.
After years of rising debt levels that were not enough to trigger a recession , Americans had largely forgotten about the clock, partly because it had been moved from a busy street corner to a quiet side street. Now they are starting to miss it, as the numbers approach the ceiling.
The debt ceiling is the amount of money Congress allows the US government to borrow to meet its basic obligations, from providing health insurance to paying the military. The current US debt ceiling is $31.4 trillion (117% of GDP).
White House economists warned on May 3 of “severe damage” to the US economy in the event of a debt default, warning that a prolonged default could result in 8.3 million job losses and a 45% decline in the stock market.
Without a deal between Congress and the White House, the federal government will lack the accounting tools to continue borrowing and could begin defaulting on its debt as soon as June 1, US Treasury Secretary Janet Yellen warned.
The US national debt clock in Times Square, New York, in November 2022. Photo: The Conversation
Political deadlock
During a press conference after announcing a 0.25% interest rate hike on May 3, Fed Chairman Jerome Powell was asked what the Fed would do if the US defaulted on its debt.
Mr Powell has insisted that the US government needs to pay back its own loans, otherwise the central bank can do little to prevent an economic downturn.
“There is no good reason other than political negligence for the United States to default on its debt,” a spokesman for House Speaker Chad Gilmartin also said. “There are plenty of revenue streams that are coming in to pay the interest on that debt.”
The default only involves federal loans, according to the statement, but administration officials warn that missed payments to contractors, Social Security recipients, federal employees and others also pose a risk of triggering a default.
US Treasury Secretary Janet Yellen called on the US Congress to “protect the full faith and credit of the United States by acting as soon as possible” to address the looming US$31.4 trillion debt ceiling. Photo: Free Malaysia Today/AP
At this point, the United States would face either a sovereign default or a massive cut in government spending. Either outcome would devastate global markets. A default would erode confidence in the world’s most important financial system, while a massive budget cut could trigger a deep recession.
Even if the US Congress raises the debt ceiling before anything serious happens, the current situation is a warning about America's declining financial health.
A bill proposed by Republican House Speaker Kevin McCarthy would push the cap to 2024, while cutting trillions of dollars in spending over the next decade and scrapping plans to combat climate change.
The bill passed the Republican-controlled House of Representatives on April 27, but failed to pass the Democratic-controlled Senate. Both sides are in a political deadlock.
President Joe Biden has invited leaders from both parties to a meeting at the White House on May 9 to work out a solution, but he also hopes they will reach a “clean” bill (one that does not include any conditions) to raise the debt ceiling.
Tough situation for the Fed
Mr. Powell said the Fed would not be involved in these negotiations. “We are not giving advice to either side. We are just pointing out that this is an important issue that needs to be resolved.
The Fed Chairman also said that not raising the debt ceiling would bring unprecedented risks and would have unpredictable impacts on the US economy.
However, “no one should think that the Fed can protect the economy, the financial system and the reputation of the United States from the potential impacts of a default,” Mr. Powell said after the Fed concluded its two-day policy meeting.
In fact, after the Silicon Valley bank’s failure on March 10, the Fed took steps similar to what it might do with defaulted U.S. debt, which is to accept securities that have declined in face value as collateral for banks’ loans.
"The Federal Reserve cannot protect the US economy from bankruptcy," Fed Chairman Jerome Powell affirmed. Photo: NY Post
The move broke a long-standing central bank policy that collateral should only be accepted at a lower value to minimize the moral and financial risks of providing such loans.
However, it also helps limit potential financial turmoil based on the assumption that the US government will eventually repay the full value of its Treasury bonds and bills even if they trade below par for a period of time.
Having served as Fed chairman since February 2018, Mr. Powell has repeatedly shown a willingness to ignore old practices when he feels it is necessary.
Facing the threat of inflation in the US in 2020, Mr. Powell shifted the focus of the Fed's policy from prices to employment. However, this decision was controversial when inflation began to surge in 2021.
To control the situation, he once again adjusted his policy, while declaring that he was ready to pay the price if unemployment increased.
This time, a default could put him in front of a difficult decision, even though his motto is “never say never . ”
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