Why in news?

• Days before the US govt’s debt default deadline, President Biden and House Speaker McCarthy reached an agreement in principle to raise the nation’s legal debt ceiling.

What’s in today’s article?

• US debt ceiling
• News Summary

U.S. debt ceiling

• Origin of debt ceiling in US
  • In 1917, Congress passed the Second Liberty Bond Act, to allow then-President to take out funds for the First World War without waiting for the approvals of absent Congress lawmakers.
  • However, the Congress created a limit on borrowing, thus creating a debt ceiling that could only be raised by approval of the Congress (House and Senate).
    • This ceiling was created to curtail the President’s spending capacity.
• Debt ceiling in its current form
  • The debt ceiling started to take its present-day form in 1939, when separate borrowing caps for bonds were consolidated into one debt ceiling.
    • At that time, it was set at $45 billion.
  • The U.S. government has hit or come close to hitting the debt ceiling multiple times.
  • While the government continues to receive taxation revenue after hitting the debt ceiling, it cannot borrow any more to pay its existing bills.

Current debt ceiling crisis

• The Democrats-led US government had in January hit its debt ceiling — the amount it is legally allowed to borrow for its expenses.
• With no new money coming in, Treasury Department Secretary had warned that funds would run out by the first week of June 2023.
• Since then, the Republican-dominated House of Representatives and President Biden’s White House have failed to reach a consensus to raise or suspend the debt ceiling.
• This stalemate led to the current debt ceiling crisis in USA.

What will happen if the U.S. defaults?

• If the debt ceiling is not raised once the government reaches the ceiling and runs out of cash, the U.S. would be unable to pay its debt-holders, resulting in a default.
• Domestic payments
  • In this case, the government would be unable to pay its bills including military salaries, benefits to retirees, and interest and other payments it owes to bondholders.
• Global financial crisis
  • If the government cannot make interest payments to domestic and foreign investors, it could plunge the globe into a financial crisis.
  • It would also increase the national debt, in turn causing widespread interest rate hikes for business owners, mortgages, and other sectors.
  • A drop in U.S. consumer confidence would translate to shocks in the financial market, tipping the economy into recession.
  • More than half of the world’s foreign currency reserves are held in U.S. dollars. Hence, a US default would affect the treasury markets around the world.
    • A loss of confidence in the U.S. economy could force investors to sell U.S. Treasury bonds, thus weakening the dollar.
    • A sudden decrease in the currency’s value could domino across treasury markets as the value of these reserves drops.
• Downgraded creditworthiness of US
• A U.S. default could lead to another downgrade of U.S. creditworthiness by agencies which in turn would raise the cost of borrowing for the government.
• Impact on economy
  • It would result in large-scale job losses, weakening of the dollar, stock sell-offs.

News Summary: US debt ceiling crisis

• President Joe Biden and Republican House Speaker Kevin McCarthy agreed on a deal that can potentially avert the US debt ceiling crisis.

key points of the deal

• A cap and a raise
  • Under the deal, the $31.4 trillion debt ceiling will be suspended until January 2025. Till then, the government can keep borrowing to fund itself.
  • In return, the White House has agreed to cap non-defence discretionary spending at 2023 levels in 2024, and increase it by 1% the year after.
• Work requirements made stricter
  • From the Democrat side, President Biden has agreed to increase work requirements for those who avail of government food stamps.
    • Supplemental Nutrition Assistance Program (SNAP) benefits are commonly known as food stamps.
    • Able-bodied adults between the ages of 18-49 and without dependents were subject to work requirements to maintain eligibility for SNAP benefits.
      • Under the current deal, the age limit will be raised to 54.
    • These requirements included actively seeking employment, participating in a suitable employment and training program, or working a minimum number of hours per month.
• Streamlining energy projects approval
• The government has agreed to the Republican demand of a more streamlined system of approval for energy projects.
• IRS, Covid fund
  • Under the deal, the outlay the Biden government had secured for beefing up the Internal Revenue System (IRS) sees a cut.
  • Leftover Covid relief fund will be taken back, including that kept aside for tackling disasters.