US Debt Ceiling

The Debt Ceiling is a political device that places a hard limit ($31.4 trillion currently) on Gross
Government Borrowing. Congress must agree to raise or waive the ceiling to prevent the treasury
from failing to make bond payments or meet spending obligations.

This time Janet Yellen, the treasury secretary, has warned that the government may run out of
cash and accounting manoeuvres as soon as June 1st. And so, on May 9th, congressional leaders
gathered in the Oval Office with President Joe Biden for the very first stage of negotiation. They are a
long way from a deal. (Economist)

What would a Default mean?

T-bills” are the closest thing there is to a risk-free asset. This makes them a favourite of corporate
cash managers (who want an ultra-safe return) and any trader needing to post collateral (which must
hold its value and be easy to sell). If the government stiffs corporate treasurers, companies will miss
payments to one another and the wheels of commerce will grind to an agonising halt. Make traders’
collateral vanish, and financial contracts of all stripes will start to fall apart, unleashing chaos in global
markets. (Economist)

Current Situation:

Investors are rushing to buy T-bills that mature before a potential U.S. default, causing significant
fluctuations in the yield on these T-bills, which are typically seen as the safest investment in the world.
This suggests that concerns about a potential default are causing volatility in a usually stable market.

Longer-term Treasuries have so far seemed safer, under the assumption that an actual default would
shock politicians out of their stubbornness and would be quickly rectified. Yet even they are not
immune. The cost of insuring five-year Treasuries against default, once the very definition of throwing
away money, has quadrupled over the past 12 months (a fact admittedly explained in part by the
market’s lack of liquidity)

If investors believe a U.S. default is unlikely, they might see opportunities to profit during the
uncertainty. However, even if a default is avoided, the aftermath could still lead to decreased market
liquidity and higher yields, which could impact all investors.

How the Debt Ceiling Affects the Stock Market?

The debt ceiling has the potential to cause a lot of volatility in the stock market due to the uncertainty
it creates. When investors are uncertain about the government's ability to pay its debts, they may
become more risk-averse and start selling their stocks. This selling pressure can cause stock
prices to decline, as investors try to reduce their exposure to risk.

In technical terms, the debt ceiling creates a negative shock to the market, which can lead to a decline
in investor confidence. This negative shock can cause a shift in the demand for stocks, as investors
look for safer assets. This can lead to a decline in stock prices, as the supply of stocks exceeds the
demand.

Additionally, the debt ceiling can also affect interest rates, which can have a significant impact on the
stock market. If interest rates rise as a result of the debt ceiling, it can make it more expensive for
companies to borrow money, which can lead to a slowdown in economic growth. This can cause stock
prices to decline, as investors become more pessimistic about the prospects for corporate earnings.

Examples:

- Analysts at pimco, an asset manager, note that over the past dozen years, the s&p 500 index has fallen
by an average of 6.5% in the month running up to a debt-ceiling deadline—even though these have
always been met. Under a default it would fare much worse. In 2013, during a previous debt-ceiling
stand-off, Fed officials simulated the effects of a month-long default. They estimated that stock prices
would fall by 30% and the dollar by 10%
 - One of the most notable examples of how the debt ceiling can affect the stock market occurred in 2011.
At the time, the US government was approaching its borrowing limit, and there was a political standoff
over whether to raise the debt ceiling. This led to a lot of uncertainty and volatility in the markets, as
investors worried that the government might default on its debt obligations. As a result, the stock market
experienced a sharp decline, with the S&P 500 falling nearly 17% between July and October of
2011. In addition, the VIX, which is a measure of market volatility, spiked to its highest level since the
financial crisis. The uncertainty caused by the debt ceiling also led to a downgrade in the US
government's credit rating, which further added to the market's woes.

- Another example of how the debt ceiling can affect the stock market occurred in 2018. In February of
that year, the US government reached its borrowing limit, and there was a lot of uncertainty about
whether Congress would raise the debt ceiling in time to avoid a default. This led to a lot of volatility
in the markets, with the Dow Jones Industrial Average falling more than 10% in just a few days.

- Another example occurred in 2019, when the US government reached its borrowing limit in
March. This led to a lot of uncertainty and volatility in the markets, with the S&P 500 falling
nearly 3% in the month of March. However, Congress ultimately passed a bill to raise the
debt ceiling, which helped to stabilize the markets.
-

Global Market Impacts:

The US debt ceiling can have a significant impact on international stock markets. This is because the
US is the world's largest economy and a major player in global financial markets. If the US
government is unable to raise the debt ceiling, it could lead to a default on its debt obligations, which
would have far-reaching consequences for the global economy.

A US default could cause a flight to safety, with investors seeking out safe-haven assets such as gold,
the Swiss franc, or the Japanese yen. This could lead to a decline in demand for other assets,
including stocks, which could cause stock prices to fall.

In addition, a US default could lead to a global financial crisis, with banks and other financial
institutions suffering significant losses. This could lead to a contraction of credit markets, which could
hurt businesses and individuals around the world.

Example:
In addition, a US default could lead to a global financial crisis. If the US is unable to pay its debts, it
could cause a chain reaction of defaults among other countries and financial institutions. This could
lead to a contraction of credit markets, which could hurt businesses and individuals around the world.

One example of how the US debt ceiling can impact global markets occurred in 2011. At the time, the
US government was approaching its borrowing limit, and there was a lot of uncertainty about whether
Congress would raise the debt ceiling in time to avoid a default. This led to a lot of volatility in the
markets, with the S&P 500 falling nearly 17% between July and October of that year.

The uncertainty surrounding the US debt ceiling also led to a decline in the value of the US dollar, as
investors sought out other currencies as safe-haven assets. This had a ripple effect on other
currencies, with the euro and other currencies also declining in value.

Another example occurred in 2013, when the US government shut down for 16 days due to a budget
impasse. This led to a decline in consumer confidence and a slowdown in economic growth, which
had negative consequences for global markets.

Why the Debt Ceiling Matters:

1. Ability to Meet Existing Obligations: When the U.S. Treasury cannot borrow beyond the
debt ceiling, it may run out of money to pay all of the government's bills, including interest and
principal on the national debt, salaries, pensions, tax refunds, contractual obligations, and
 other payments. This can lead to a default on obligations, which has never happened in the
history of the United States.
2. Global Economic Impact: The United States Treasury securities are considered the safest
assets in the world because the U.S. has always paid its debts on time. If the U.S. were to
default, it could shake confidence in the global financial system. U.S. government bonds are a
benchmark for other financial markets, and many institutional investors, like pension funds
and central banks, hold large amounts of U.S. debt. A default could cause interest rates to
spike and markets to plummet worldwide.
3. Credit Rating: The United States has traditionally enjoyed a high credit rating due to its
reliable repayment of debts. A failure to raise the debt ceiling and subsequent default could
lead credit rating agencies to downgrade this rating. This is what happened in 2011 when the
U.S. came close to breaching the debt ceiling and Standard & Poor's downgraded the U.S.
credit rating for the first time ever from AAA to AA+. A lower credit rating can increase the
cost of borrowing, not just for the U.S. government, but also for businesses and consumers,
leading to slower economic growth.
4. Political Implications: The debt ceiling is often used as a political tool, with lawmakers
refusing to increase the limit without certain concessions. These standoffs can lead to
financial uncertainty and potentially disrupt government operations if not resolved quickly.
5. Government Shutdowns: If lawmakers can't agree on raising the debt ceiling, it could lead to
a partial or full shutdown of the government, as it runs out of money to fund operations. This
can lead to delays in government services and unpaid furloughs for federal employees,
among other effects.
6. Domestic Economic Impact: The uncertainty around whether the debt ceiling will be raised
can have a negative impact on the economy. Consumer and business confidence can fall,
leading to reduced spending and investment, which can slow economic growth and potentially
lead to job losses.

Revisions to the Debt Ceiling:

Since 1960, it has done so 78 times: 49 times under Republican presidents, and 29 times when a
Democrat was in the White House. 

1917: The Second Liberty Bond Act of 1917 is passed, effectively creating the debt ceiling as a way to
finance U.S. participation in World War I. Before this, Congress had to approve every issuance of
debt.

1939: Congress establishes the first aggregate limit that covers nearly all public debt.

1946-1954: After World War II, the U.S. reduces its debt for the first time since 1917. However, after
1954, the debt begins to increase again.

1974: The Congressional Budget Act of 1974 is enacted, which establishes a budget process that
coordinates decisions on revenue, spending, and debt limit legislation.

1979: The House of Representatives adopts the Gephardt rule, which provides that a debt limit
increase is automatically included in the budget resolution, avoiding a separate vote.

1985: The Balanced Budget and Emergency Deficit Control Act of 1985, also known as the Gramm-
Rudman-Hollings Act, is passed. This act automatically triggers spending cuts if the deficit exceeds
certain targets, but it is later ruled unconstitutional.

1995-1996: A political standoff between President Bill Clinton and Republicans in Congress leads to
two government shutdowns.

1997: The Budget Enforcement Act of 1997 suspends the debt limit from August 5, 1997, to June 30,
2002.
2011: A significant debate occurs over raising the debt ceiling. The ceiling is eventually raised, but
only after a protracted political fight and a downgrade of the U.S. credit rating by Standard & Poor's.
2013: The debt ceiling is suspended from February 4, 2013, through May 18, 2013.

2015: The debt ceiling is suspended again from November 2, 2015, through March 15, 2017.

2017: President Donald Trump signs a bill suspending the debt ceiling until December 8, 2017. The
limit is then suspended twice more, ultimately until March 1, 2019.

2019: President Trump signs a two-year budget deal that suspends the debt ceiling until after the
2020 elections. The deal suspends the debt limit through July 31, 2021.

2021: The suspension of the debt ceiling expires on August 1, 2021. The U.S. Treasury begins taking
"extraordinary measures" to prevent a breach of the debt ceiling.