Client update - 19th May 2023

The US debt ceiling discussions are reaching a crescendo and whilst we do not believe that the US will actually voluntarily default on its debt obligations, such is the huge disagreement between the Republicans and the Democrats that, the possibility remains and could come to pass as early as 1st June 2023.

Let me start with a sensible question - what actually is the US “Debt Ceiling”? The US traditionally runs a deficit – meaning that it spends more than it takes in tax receipts. In 1917 the US introduced a law that set a statutory limit to the amount of debt that the Government is allowed to accrue. This was originally set at $11.5bn. This limit is not increased when the Government decides on the level of spending and taxes, instead it is only reviewed once the new limit is almost reached. It also does not allow for natural factors – such as the impact of high inflation. This opens the way to last minute wrangling to try and score political points as any increase has to be voted through the House of Representatives. The political atmosphere in the US House has been volatile anyway of late, with the start of the Presidential election process.

The US debt ceiling currently stands at $31.4 trillion, and this level of debt was actually reached earlier in the year – technically meaning the Government cannot borrow any more money. The House of Representatives is controlled by the Republicans, so the in situ Democratic President Joe Biden is coming under significant pressure to cut future spending to get any increase approved. Technically, if the US Government cannot spend any more money, then it cannot pay public sector workers or service its existing debt.

What makes this situation rather bizarre, and therefore very much made in America, is the fact that a default can always be avoided by mutual agreement, therefore any default is actually a matter of choice. This brinkmanship is not a new thing. In 2011 the agreement to increase the ceiling was passed on the same day the Government ran out of money, a situation very nearly repeated in 2013. With currently high interest rates, the cost of servicing debt increases and the threshold can be reached very quickly. Such high levels of public debt is very much a modern phenomenon – in 2011 the US federal debt was 65.8% of US GDP – it is now almost 98%.

President Biden has cut short his trip to Asia to try and help talks to progress and he is no stranger to this process having endured last minute negotiations in 2021. Republican proposals would cut non military discretionary spending by 47% between 2024 and 2033. There have even been suggestions that a default would help the Republican Presidents chances of election in 2024. These matters will undoubtedly be resolved, however they are causing markets to pause for breath. The joy of politics. This is quite a game of chicken – but I am sure you had enough of that in my update last week. Do have a good weekend.