Political games and bickering in Washington pose a threat to global financial stability
The United States has once again reached a critical point in its debt crisis, with its outstanding unfunded federal government debt reaching a staggering $31.41 trillion in December. While the US Treasury Department has taken emergency measures to avoid breaching the debt ceiling, the ongoing power struggle between Democrats and Republicans threatens to deepen the crisis.
The fear of a debt default looms large. US Treasury Secretary Janet Yellen warned Congress on May 1 that the US might be unable to pay the bills as early as June 1 if lawmakers do not raise or suspend the debt limit, warning that failure to act could lead to severe global consequences.
A potential downgrading of the US sovereign debt rating, a weakened US dollar as a global reserve currency, and a global financial crisis are all possibilities.
Printing currency notes and issuing bonds have been the two major policy tools of the US to stimulate its economy. As a result, the dollar standard has evolved into a debt standard for the US.
The debt ceiling is essentially the maximum limit on the total amount of federal government debt. It is a legal restriction set by Congress and used as an important means to limit federal government debt. The debt ceiling covers 99 percent of the total amount of US federal debt, including publicly held debt (used to finance budget deficits) and debt issued to federal government accounts (used to fulfill federal obligations).
The debt ceiling was set to prevent the federal government from borrowing recklessly, and since 1917 Congress has set the limit on the issuance of bonds through legislation. Yet the US debt ceiling is a symbolic limit because the legal debt limit has been continuously raised. From 1997 to 2022, the US raised the debt ceiling 22 times.
Over the past 20 years, the statutory debt limit has increased from $6.4 trillion to $31.41 trillion. At the end of the 2022 fiscal year, total US federal debt was $30.93 trillion, or 121.5 percent of GDP. The total outstanding public debt exceeded the combined economic output of China, Japan, Germany and the United Kingdom.
The increase in debt is fueled by the monetization of debt. The Federal Reserve is the second-largest holder of US government debt. The Fed purchases government bonds in the secondary market and gives the newly printed currency bills to primary dealers who then transfer them to the Treasury Department.
The expansion of the Fed’s balance sheet, when combined with the federal government’s fiscal deficit and the size of the Fed’s assets and liabilities in the balance sheet (or holdings of government bonds), is the process of debt monetization.
Also, the proportion of US Treasury securities held by foreign creditors declined significantly between 2008 and 2020, while the proportion held by the Fed increased drastically. To ensure the US government’s spending growth rate does not decline, the federal government must continue to rely on the Fed to finance its Treasury securities.
Unbridled printing of money has not only led to excessive global liquidity and debt expansion, it also puffed up the Fed’s balance sheet to an unprecedented $8.9 trillion. In response to the high US inflation rate, the Fed has raised interest rates 10 times since March 2022. The cumulative increase of 500 basis points is the most aggressive hike cycle since the 1980s.
But the aggressive rate hikes have significantly increased the cost of servicing the US’ federal debt. According to Congressional Budget Office estimates, US federal debt will incur $2.5 trillion in servicing costs between 2022 and 2031.
Essentially, the US can continue to borrow and roll over its debt as long as its fiscal revenue can cover the government’s interest payments, thanks to the US dollar’s dominant international currency status.
However, the sharp rise in US debt poses a serious threat to this strategy. In the long run, the federal government’s debt will not be sustainable. Although the US has not yet defaulted on debt, political turmoil and financial market shocks should not be underestimated.
The debt ceiling has become a key bargaining chip in political games between the Democrats and Republicans. The current situation is reminiscent of 2011, when debt ceiling negotiations between the Barack Obama administration and the Republicans who controlled the House of Representatives were deadlocked right until the day the Treasury Department ran out of funds.
This intense standoff led to Standard & Poor’s downgrading the US sovereign credit rating for the first time from AAA to AA+, triggering turmoil in global markets, with gold prices soaring nearly 13 percent and the S&P 500 stock index plummeting 17 percent in a month.
With Congress divided again, the stalemate over debt ceiling is likely to become another headache for the Joe Biden administration, as the Republican majority in the House of Representatives, with their control of the purse strings, will make every effort to block the passage of a bill to raise the debt ceiling.
This will not only impede the Fed’s asset liability plan to combat high inflation, but also could accelerate the sale of US Treasury bonds, damage the credibility of the US dollar as an international reserve currency, and trigger another global financial crisis.
The author is deputy director of the Institute of American and European Studies at the China Center for International Economic Exchanges.
The views do not necessarily reflect those of China Daily.