Abstract

• The U.S. debt ceiling has been raised or modified 78 times since 1960, but each time it becomes a political showdown between the two parties. After months of brinkmanship, a tentative deal has been reached to suspend the debt limit until 2025.
• The U.S. debt ceiling has turned into a political weapon for the two parties, who use it to advance their own agendas and interests. Meanwhile, the global financial market is also at the mercy of the outcome of the negotiations.
• Raising the debt ceiling is not a sustainable solution to the national debt problem. The U.S. government resorts to this “easy way out” without addressing the root causes, but this only postpones the inevitable crisis and undermines the stability of the global financial system.

Where does the U.S. debt ceiling come from?

Under the "separation of powers" system in the U.S., Congress has the power to approve fiscal spending and borrowing. The debt ceiling is the maximum amount of debt that Congress allows the government to incur through legislation, similar to our "credit card limit". The purpose of this is twofold: first, to prevent excessive government borrowing; and second, to facilitate government financing. Within the scope of the debt ceiling, the government does not need congressional approval to increase debt, but if it reaches the limit, the government cannot increase debt and must obtain congressional consent to raise or suspend the debt ceiling.

Before World War I, Congress often authorized borrowing for specific purposes, such as building the Panama Canal. Congress also often specified which types of financial instruments the Treasury could use and set or limited interest rates, maturity dates, and bond redemption terms. In some cases, especially during wartime, Congress gave the Treasury discretion to choose debt instruments, but with broad restrictions. In 1917, Congress changed its way of authorizing debt in order to provide more flexibility to fund U.S. participation in World War I through the Second Liberty Bond Act. Under this act, Congress established a total limit, or "ceiling," on the amount of new bonds issued.

So what is the link between the U.S. debt ceiling and a U.S. debt default? The U.S. debt ceiling includes all public debt, such as bonds issued by the U.S. government held by individuals, corporations, foreign governments, and so on, as well as intergovernmental debt. If the U.S. reaches its debt ceiling, the government cannot issue new bonds to raise funds, and if the government cannot raise enough funds to pay its obligations, including maturing bonds and essential government spending, then it may default. This is why debt ceiling negotiations often cause market anxiety because markets worry that a deadlock in debt ceiling negotiations could lead to a U.S. government default.

Since the 1960s until now, the U.S. has raised or modified its debt ceiling 78 times, of which Democrats led 49 times and Republicans led 29 times.

In December 2021, the U.S. Congress passed legislation to raise the federal government’s debt ceiling to about $31 trillion (U.S. 2022 GDP is $25.47 trillion, and debt is 123% of national GDP). On January 19 this year, the U.S. government’s debt reached its legal borrowing limit, making it unable to finance it through issuing bonds. To prevent government shutdown and default, the Treasury Department could only continue paying civil servants’ salaries and social welfare as well as interest on existing debts through unconventional accounting methods, but unconventional methods cannot support a long time. After months of tug-of-war between two parties, they finally reached a principled agreement before the deadline, agreeing to suspend the U.S. debt ceiling until 2025, limit government spending during this period, and increase military spending by about 3%, but a final vote has not been conducted yet.

Who wins and who loses in this standoff?

In fact, for most of American history, raising the debt ceiling was just a routine "procedural" issue. But in recent years, as social divisions deepened, party polarization worsened, and the debt burden grew, the debt ceiling gradually evolved into a political bargaining chip, with the interests and political goals of two parties as objectives.

Democrats and Republicans, when in power, in order to please voters, overspend the fiscal budget. After stepping down as opposition parties, they strongly oppose the passing of the debt ceiling bill, creating obstacles for the ruling party’s governance while seeking more benefits for their own party and policies. For the American people, the debt ceiling crisis will have a significant impact on their health care, education and public services, etc. daily life aspects. At the same time, this crisis occurred when expectations of a U.S. economic recession strengthened, increasing market uncertainty about the U.S. economic outlook.

Historical data summary shows that when the debt ceiling is just reached, the market often does not have a big impact; the impact on the market is often not obvious; and in the last month before the deadline arrives, the impact is most significant: U.S. stocks,U 10-year Treasury yield, U.S. dollar index fall, short-term Treasury yield rise, gold price rise. This reflects that deadlock on the debt ceiling will suppress market risk appetite and cause worries about default on maturing U.S. Treasury bonds, but this effect is short-term; when the crisis on the debt ceiling is lifted, market risk appetite will welcome repair, and price trends of various assets often reverse.

For example, in 2011, the then-U.S. President Obama and House Republicans reached agreement on the debt ceiling at the last minute, barely avoiding disaster, but the resulting tension triggered global capital market volatility, directly leading Standard & Poor's to downgrade the U.S.'s AAA sovereign credit rating. In 2013, the two parties again fell into deadlock on negotiating on raising the federal borrowing limit over issues such as cutting social welfare and health care reform, leading to a government shutdown for half a month. The same script was staged again this year.

It can be seen that except for American politicians gaining their own political capital and interests, no one seems to really benefit.

Raising the limit indefinitely: Is there no problem for the U.S.?

Although negotiations on raising the federal borrowing limit may bring great political drama, historically, the U.S. government has never defaulted because of problems with the federal borrowing limit. Normally,Congress will eventually reach an agreement at the last minute, increase the federal borrowing limit, and thus avoid default.

Then the question comes: in the future, if America continues to agree to raise the federal borrowing limit and borrows heavily, and when one day it is really unable to pay debt interest, what will happen? Although the possibility of this happening within the next few years is not high, this potential risk will always exist.

Obviously not. The current federal borrowing limit for the U.S. is $31.4 trillion, which is 123% of its GDP. This means that America has to pay several hundred billion dollars in interest every year. According to Peter G. Peterson’s statistics, the U.S.‘s various debts’ interest in 2021 was $352 billion, and in 2022, interest expenditure will be $475 billion. Now that the federal borrowing limit has been raised again, this means that every year the cost of paying interest will increase. According to a previous prediction by the White House Office of Management and Budget, in the U.S. around 2033, every year’s interest expenditure will exceed $1 trillion. This number is astronomical even for America (Canada’s GDP in 2022 will be $2.1 trillion, and the U.S.'s interest equals half of Canada’s entire country GDP).

Why does America spend so much then? Take 2022 fiscal year as example, the U.S.whole year expenditure was $6.3 trillion, income was $4.9 trillion.Not talking about making money, last year already net loss $1.4 trillion.Let’s break down expenditure details:Social Security was $1.2 trillion, military spending was $767 billion,$677 billion, and other transportation, housing, veterans benefits etc etc expenditure.

Thus, the space for saving money by increasing revenue or reducing expenditure for America government also seems not big, and possibility also seems not high.Then when America government future always raising federal borrowing limit, borrowing heavily, and when one day really unable paying debts interest what will happen?Although possibility of this happening within next few years is not high, but this potential risk will always exist.

Investment ideas and suggestions

Based on the fact that America never defaulted, U.S.Treasury currently still publicly recognized safe investment asset by market. U.S. core inflation still high, current market wait-and-see sentiment strong, movement changes fast leading asset price fluctuation.We still suggest investors allocate fixed income assets, diversify asset allocation while increasing lower gear protection.