As you read this mid-week note, there is uncertainty in the financial markets relating to the amount of debt that the United States government can incur.
The US might default around the June 1st deadline!
What exactly is a debt ceiling?
When the US government spends more money than it collects in revenue, it must borrow money by issuing Treasury bonds and other securities. However, there is a limit set by Congress on the amount of debt the government can accumulate. Once the government reaches this limit, it cannot borrow any more money unless the debt ceiling is raised or suspended. The debt ceiling is, essentially, a legal limit on the total amount of money that the US government can borrow to fund its operations and meet its financial obligations.
Can the US government really default?
Technically yes, but it is widely considered highly unlikely. But in the history of the US Treasury, there have been four explicit defaults on the debt before:
1. In early 1862, following Civil War
2. Default on bonds in 1933
3. In 1968, when the US government refused to honour its explicit promise to redeem its silver certificate paper dollars for silver dollars, &
4. In 1971, when the US government broke the commitment to redeem dollars held by foreign governments under the Bretton Woods Agreement.
What happens next?
If the debt ceiling is not raised or suspended in a timely manner, the government may face difficulties in meeting its financial obligations, which could potentially lead to a default on its debt. Policymakers must decide whether to raise the limit, suspend it temporarily, or take other measures to address the situation.
Fyi, historically, the US debt ceiling has been raised 78 times since 1960. Most economists expect a similar decision this week. However, any delay in getting a consensus could prolong the tension and keep the global markets volatile. It could also lead to a further rise in gold prices as it is considered a safe haven. Moreover, we believe that this problem is much more structural. Solutions like fiscal reforms, control of spending, and enhancing revenue generation capabilities are more long-term solutions to this debt ceiling problem.