Governments spend more money than they earn and finance the difference through borrowing.
The government of United States (US) is no different on this front. The trouble is that it cannot borrow beyond a certain limit. This limit, known as the debt ceiling, was set at $16.69 trillion.
This ceiling should have been breached in May 2013, a little earlier this year. Since then, Jack Lew, the American treasury secretary, has taken a number of extraordinary measures like delaying public employee pension fund payments, in order to ensure that the government expenditure remains under control. Lesser expenditure meant lesser borrowing and hence, the government managed to keep its total borrowing below $16.69 trillion.
Today i.e. October 17, 2013, the government would have run out of the extraordinary measures that it has been taking. Given this, the treasury department would have exhausted its borrowing authority.
Hours before this would have happened, the leaders of the Democratic Party and the Republican Party in the American Senate stuck a deal, suspending the debt ceiling. This will allow the US government to borrow beyond $16.69 trillion, till February 7, next year. The will also end the current government shut-down in the US and keep the government running along till January 15, 2014.
This is not the first time that the US government came close to its borrowing limit, given that the debt ceiling has been in place since 1939. Since 1960, the debt ceiling has been raised 78 times by the American Congress. But this time around the Democrats and the Republicans left it too late, each waiting for the other to blink first.
If the ceiling had not been extended the short-term repercussions would have been terrible. The treasury secretary Lew had said in early October that the US government “will be left...with only approximately $30bn” come October 17. This would not be enough to meet the expenditure of the government, which can be as high as $60 billion on some days, Lew had pointed out.
Interest payments of around $6 billion are due on US government bonds before the end of this month. Along with that, bonds worth between $90 to $93 billion need to be repaid between October 24 and October 31 (Source: www.thefinancialist.com) Governments issue bonds to borrow money.
The US government has reached a stage wherein it does not earn enough to repay the money it has already borrowed by issuing bonds. Hence, it has borrow more money by issuing fresh bonds to pay off the older bonds. If the debt ceiling had not been extended, it would have become very difficult for the US government to repay the money it had already borrowed.
More importantly, the US government bonds are deemed to be the safest financial security in the world. If the US government defaulted on paying interest on its bonds or repaying the principal, there would have been mayhem in financial markets, all over the world, including India. It has even been suggested that the crisis that could have unfolded would have been bigger than the crisis that followed the bankruptcy of Lehman Brothers in September 2008. Investors would have sold out of US government bonds driving up global interest rates.
The US government would also have had to prioritise its expenditure. Does it make pension payments? Does it pay its employees and contractors? Does it pay interest on its bonds? Does it repay maturing bonds? These are the questions it would have had to address. Also, there are no legal provisions guiding the government on who to pay first. Hence, any prioritisation of payments could have led to a slew of lawsuits against the US government.
Given the negative repercussions of the debt ceiling not being extended, the markets were positive that a deal reached would be reached. Stock and bond markets around the world have been stable. And gold, looked at as a safe haven, is quoting at levels of around $1280 per ounce (one troy ounce equals 31.1grams).
The trouble is that the US government will cross its debt ceiling level again in February, 2014.
What happens then? How long can the American Congress keep increasing the debt ceiling? The basic problem is that the US government has borrowed too much money, and continues to do so, and if it doesn’t default today, it will default in the years to come.
(Vivek Kaul is the author of Easy Money. He can be reached at firstname.lastname@example.org)