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Business Analysis & Features

The US Debt Ceiling: Is America in danger of default?

What is a debt ceiling?

As the name suggests, it's an absolute limit on national debt. The UK doesn't have one, though Budgets have to be approved by Parliament, but the US has had one since 1940, when it was set at a modest $49bn.

How high is the ceiling?

High, by any standards. The current limit is $14.294 trillion, ie $14,294,000,000,000 – fourteen million million dollars. Even set against the largest economy in the world, it is still pretty impressive; approaching 100 per cent, the highest in America's peacetime history.

When will America run out of money?

The US Treasury say that they will run out of money to pay their debts on 2 August. That is the date when book-keeping dodges run out and the train hits the buffers. An emergency, short-term fix could avert disaster, but for now the wrangling between the President and Congress continues.

Why can't they agree?

President Obama is reluctant to cut social and health programmes. His Republican opponents in Congress, especially the "Tea Party" faction ("nutters" according to our own Vince Cable) refuse to countenance tax rises, because they would hurt the recovery. Most economists say both will be needed to fix the deficit in the short or long term.

What if the ceiling is hit?

First, the federal government's spending will be limited to its cash flow – no more borrowing. Given that the tax revenues only provide for 60 per cent of government spending it implies a 40 per cent plus cut in government spending immediately - rather more draconian than even the British austerity programme. The US Treasury would have to decide which government employees get paid and which have to do without pay. The decision point would be $23bn in Social Security payments due on 3 August, not covered by tax revenues. Bad as that is, there is a second unpleasant consequence; that the US would have to tell those investors cashing in their bonds that it cannot honour them. Such a default would send shockwaves around financial markets.

What happens then?

No one knows, as, with the UK and a few others, the US has never run away on a debt (not counting inflation).

Any good news?

The international body that represents the credit ratings agencies say that it might not treat the default as a default. The financial panic might not then happen.

Can the US pay its bills?

Yes. The American "default", unlike the recent one in Greece, say, is entirely technical. The US is in the fortunate position that it can virtually print as much money as it wants, so willing is the world still to accept US Treasury bills and bonds as "safe" assets. There are limits to that – hence the popularity of gold and the Swiss Franc – and long term the US will have to live within its means. But, for now, the Chinese, Gulf states and others are happy to hold their paper.

Long-term damage?

Potentially great. Missing bond interest payments or redemptions would mean that the credit rating agencies would downgrade the US. That would mean Americans would have to pay more interest on their mortgages and other borrowings than otherwise; it would cost them real money every month. Any sustained drastic reduction in US government spending would also threaten to push America back into recession.