US shutdown and debt ceiling come to a head
Every so often, the US debt ceiling and the government shutdown come into play and cause anxiety on financial markets. This is again the case today, with both in play at nearly the same time. Not only are the usual risks associated with shutdowns and looming debt ceilings in the spotlight, but political fights over Biden’s larger policy agenda are also in the mix. Indeed, Democratic leaders are pushing to pass the bipartisan 1 trillion dollar infrastructure bill this week despite the fact that the second, larger spending bill (focused on social policy) has not yet passed the Senate. This may be a tactic to push forward negotiations on the larger bill, which would be passed through a process called reconciliation, and could theoretically include an increase of the debt limit without Republican support. Meanwhile, Republicans have already blocked a stop-gap funding bill that would avoid a shutdown while also raising the debt ceiling. In a sense, US lawmakers are taking political posturing to its extreme, on issues that could potentially have significant consequences for the global economy. However, we do believe that the debt ceiling will be raised in time again.
Shut down vs debt ceiling
Government shutdowns happen when Congress doesn’t pass the necessary bills or resolutions (signed by the president) to fully fund the government. Agencies without funding shutter non-essential services and stop paying employees until the government has reopened. The last government shutdown lasted 35 days and dates back to 2019. The next big deadline to avoid a government shutdown is 30 September 2021.
The debt ceiling is a self-imposed limit on the total amount of money the US government can borrow. Last time the ceiling had to be raised, in 2019, policymakers eventually enacted a budget deal that suspended the federal debt ceiling for two years. This deal came to an end on 1 August 2021 when the debt limit was reinstated at 28 trillion dollar, the level covering all borrowing during the suspension. Since then, Treasury Secretary Yellen has deployed the emergency borrowing authority—known as “extraordinary measures”—to continue fully funding government operations. Once the extraordinary measures are exhausted, daily revenues and cash on hand can still be used to meet the government’s financial obligations, but that is the last barrier of defense. The latest analysis by the Bipartisan Policy Center estimates that the Treasury will most likely have insufficient cash to meet all its financial obligations (the so-called “X Date”) sometime between October 15 and November 4. As cash flows are difficult to predict, so is the exact X Date.
Shutdowns hurt unpaid government workers and others who rely on government services, and they can become more damaging to the economy and sentiment the longer they persist. The CBO estimated the direct nonrecoverable cost of the 2019 shutdown to have been 3 billion dollar (or 0.02% of GDP). Meanwhile, debt ceiling crises can raise interest rates, increase financial market volatility, weigh on confidence, and damage the reputation of US debt as a ‘risk-free’ asset. Increased uncertainty and tighter financial conditions in the US can have spillover effects globally and can especially weigh on growth in emerging markets. There is no recent precedent on the consequences of reaching X Day. All other debt limit impasses have been resolved in time.
Independent of the specific cause, a slowdown in the domestic US economy would also impact other countries via declining US import demand and lower US investments abroad.
Given the high stakes, it should be in the interest of both political parties to avoid the shutdown and the debt ceiling. However, just as the shutdowns are often not about budgetary disagreements, fights over the debt ceiling are not really about debt sustainability. The debt ceiling crises in 2011 and 2013 have transformed the previously non-controversial routine of increasing the debt ceiling into a perpetual game of ‘chicken’. And this debt ceiling episode is no exception.
Republicans blocked a stopgap bill to keep the government from shutting down because it included a temporary suspension of the debt limit. While the Republicans don’t want the government to shut down, they want the Democrats to increase the debt limit without Republican support. Because while suspending the debt ceiling has nothing to do with the approval of new spending, it could still be perceived that way by voters. Some Republicans have indicated that they want the Democrats to tackle the debt ceiling in a separate package so they can paint the Democrats as reckless spenders in the 2022 mid-term elections (though both parties are responsible for the higher spending that now requires a debt ceiling increase). Passing the necessary bill only with Democratic support is a bit more complicated, as it would need to be done through a process called reconciliation, which can take several weeks.
But what will be the end game?
The approach Democratic leaders now appear to be taking to avoid a shutdown or default is, perhaps surprisingly, to push forward with passing Biden’s major legislative agenda. House Democratic Leader Nancy Pelosi wants to pass the 1 trillion dollar infrastructure bill (which already passed the Senate with bipartisan support in August) this week. Progressive Democrats have said this bill can only go ahead if the larger (3.5 trillion dollar) social spending bill also gets passed in the Senate (through reconciliation). Due to push back from more conservative-leaning Democrats, the negotiations on that bill have been fraught. It may be the case that Democratic leaders want to inject momentum into passing both bills so that the debt ceiling increase can be added to the larger reconciliation bill, even though they are fully aware that passing a stand-alone stop-gap funding bill through Congress is easier. While this approach is a gamble, it could pay off with Democrats avoiding a shutdown or debt ceiling crisis and passing Biden’s agenda at the same time. Whether the gamble will pay off will become clear very soon.