Over the past few years, we've become accustomed to hearing about the political tussles around the US debt ceiling, and the stand-off and brinkmanship to raise its level. Created by Congress in 1917, the debt ceiling is the statutory maximum amount the US government is authorised to borrow to meet the existing legal obligations which Congresses and presidents of both parties have made in the past. These obligations include social security and Medicare benefits, military salaries, interest on the national debt, tax refunds and other payments.
Since 1960, Congress has acted 78 times to permanently raise, temporarily extend, or revise the definition of the debt limit. The most recent increase to the ceiling was in December 2021 to $31.38 trillion. Any change to the ceiling requires majority approval by both chambers of Congress; the Senate and the House of Representatives. Congress can also choose to suspend the debt ceiling or temporarily allow the Treasury to supersede the limit.
As the US government has run a deficit of approximately $1 trillion every year since 2001, the frequency of requests for increases to the ceiling have accelerated, along with the now familiar confrontation and sparring. The protracted wrangling between President Obama and congressional Republicans for an increase to the ceiling in 2011 sparked a very volatile weeks for US stocks. The threat of default led S&P to downgrade the US sovereign credit rating from AAA to AA+, the only downgrade in the nation’s history.
In her letter of 13th January 2023 to the House of Representatives and the Senate, US Treasury Secretary Janet Yellen estimated that the government’s outstanding debt would hit the ceiling later that month. The Treasury would then use cash balances and ‘extraordinary measures’ to prevent default on payment obligations, with these resources expected to last at least through to early June. The timeliness in either raising or suspending the ceiling was emphasised with a warning, “failure to meet the government obligations would cause irreparable harm to US economy, the livelihoods of all Americans and global financial stability.”
So, quite simply, if Congress doesn’t increase the debt ceiling before the resources run out, the government doesn’t pay its bills resulting in a first-ever default. The consequences would be huge – US government bond yields would rise as would the cost of borrowing priced off US treasury yields. Banks, sovereign funds, investment funds, insurance companies, pension companies, foreign governments all hold and rely on US Treasuries as a low-risk element of treasury and investment portfolios. The resulting repricing of US debt would have massive consequences.
With no resolution in sight and “X-date” - the date when the Treasury exhausts its cash and extraordinary measures - looming sooner than those early estimates, Ms Yellen has again written to both chambers of Congress reiterating the urgency as the Treasury’s best estimate was that it would exhaust its ability to meet all of the government's payment obligations by early June, and potentially as early as 1st June, if Congress did not raise or suspend the debt limit before that time.
At the time of writing there was little sign of the impasse between the Democrats and Republications ending swiftly (the Republicans lead the House of Representatives, the Democrats the Senate), President Biden acknowledging that “there’s going to be a lot of posturing, politics and gamesmanship and it’s going to continue for a while”. But the nervousness in markets is tangible. The increase in short-term borrowing costs is very evident in US 1-month treasury bill where the yield has increased to nearly 5.4% on 11th May from 4.57% on 31st March. The US 1-year credit default swap has been pushing higher rising since April and was 176 basis points on 11th May, signifying rising alarm of a default (for comparison, the UK’s 1-year CDS is 11.3bps and Germany’s is 5.6bps).
Is the debt ceiling replicated elsewhere?
Denmark, but its ceiling is deliberately set high to avoid political wrangles. The limit was 950 bn Danish kroner when implemented in 1993 and roughly doubled in 2010 to 2 trillion kroner. The country’s borrowing has stayed well below this cap.
The UK government doesn’t have a ceiling in absolute £ terms but sets out how it manages public finances in the Charter for Budget Responsibility. The Charter was introduced in 2011 and has been revised on several occasions.
The current Charter was approved by the House of Commons in February 2023 and includes targets for government debt and government borrowing and also a spending cap for welfare. The target, which is described as the fiscal mandate, is to have public sector net debt (excluding the Bank of England) as a percentage of GDP falling by the fifth year of the rolling forecast*. By excluding the Bank of England, underlying public sector net debt is more closely associated with the government’s choices around spending and tax and is thought to be a better measure of underlying debt.
*Target year 2027-28, as the OBR’s latest forecast was produced during fiscal 2022-23.
Should the government want to spend more than it raises from taxes and other sources, it needs to borrow. Here, the target is for public sector net borrowing not to exceed 3% of GDP by the fifth year of the OBR’s forecast period.
The European Union asks member states to limit debt to 60% of GDP, though many have tended to flout this limit. At the end of 2022, the government debt-to-GDP ratio ranged from 18.4% (Estonia) to 171% (Greece). Many countries with their debt ratio above the 60% threshold included Italy, Portugal, Spain, France, Belgium, Finland and Germany.