Listen to the Article: Will Uncle Sam Default? The Looming Debt Ceiling Crisis of 2023

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America is on the brink of an unprecedented default. Treasury Secretary Janet Yellen warned on May 1 that the US would default on its bills by June 1, 2023. That would be the first time the US has ever failed to honor its debt obligations since it started issuing bonds in 1790.

​The stakes are high for the global economy. The International Monetary Fund cautioned that a US default would have severe repercussions, such as driving up borrowing costs worldwide. Harvard economist Prof. Kenneth Rogoff said it would spark a global financial crisis.

The US Debt Crisis: What Are Deficit, Debts and Debt Ceiling?

The US has been living beyond its means for decades. Since 2001, when it last had a budget surplus, the country has spent trillions of dollars on wars, tax cuts, and stimulus programs. In fiscal year 2022, which ended in September, the federal government collected $4.90 trillion in revenue but spent $6.27 trillion, leaving a gap of $1.38 trillion (the fourth largest in this century). To cover the shortfall, the US has to borrow money from investors at home and abroad, adding to its debt pile.

But there is a legal limit to how much the US can borrow. The "Debt Ceiling", which was first introduced in 1917 to finance World War I, caps the total amount of debt that the Treasury can borrow. Congress has the power to raise or lower the limit, as it has raised 98 times and lowered 5 times from 1939 to 2018.

As of January 2023, the US owes about $29 trillion to various creditors. The top five foreign holders of US debt are Japan ($1.1 trillion), China ($859 billion), Britain ($668 billion), Belgium ($331 billion), and Luxembourg ($318 billion).

The last time the US faced a debt ceiling crisis was in 2011, under Obama Administration. The House of Representatives, controlled by Republicans, refused to raise the limit unless Obama agreed to spending cuts. The talks dragged on for months and collapsed last minute. The markets panicked - the S&P 500 index lost more than 16% of its value in the final month before the deadline. The US narrowly avoided default by striking a deal to raise the ceiling. But the damage was done - Standard & Poor's downgraded the US credit rating from AAA to AA+3 for the first time in history.

The 2023 US Debt Ceiling Crisis Explained

On January 19, 2023, the US federal government hit the debt ceiling, $31.4 trillion. Wells Fargo warned that the US could default on its debt as soon as July or as late as September this year. That would force the Treasury to choose between skipping payments to bondholders or slashing spending on various programs that Congress has already approved but not fully funded. Either way, it would be a disaster for the global economy.

Back in March, Moody's Analytics economists projected that the date would be around August 18, 2023. They hoped that Congress would raise the debt limit before then, but they also cautioned that failing to do so would have catastrophic consequences.

But in May, Treasury Secretary Janet Yellen dropped a bombshell. She said that the US could run into trouble as early as June 1. The debt ceiling crisis is a symptom of the deepening polarization in US politics.

How America Can Avoid A Default

A default by the federal government would be devastating for America's credit. It would send interest rates soaring in the US and around the world, hurting the global economy that is still recovering from the pandemic. The most likely way to prevent this from happening is to raise the debt ceiling unconditionally before the deadline, as has been done in previous crises.

Some analysts suggest that if Congress fails to act, President Biden could still avert a default by invoking Section 4 in the 14th Amendment, which says, "The validity of the public debt of the United States, authorized by law, including pensions and bounties for suppressing insurrection or rebellion, shall not be questioned." This would allow Biden to ignore the debt ceiling and keep borrowing money. But this would also spark a constitutional crisis that would likely end up in the Supreme Court.

Another option that has been floated is for the Treasury to mint a $1 trillion platinum coin and deposit it at the Federal Reserve Bank to cover its expenses. This would be based on a legal loophole that gives the Treasury the power to issue coins of any denomination. But this idea has been dismissed by the Treasury Secretary.

President Says "Default Is Not An Option" & Consequences

The US is facing a looming deadline to avoid a historic default. With only a few weeks to go, President Biden said he was still working with the Democrats to find a way to raise the debt ceiling. He said that defaulting on the nation's debt was "not an option."

This is not the first time the US has come close to a fiscal cliff. In 2019, under Trump Administration, the government shut down for 22 days, leaving more than 800,000 federal workers without paychecks, because of a budget dispute.

But there is hope that Congress will act in time to prevent a default, which would tarnish America's credibility. However, this would only be a temporary fix, and it would have negative consequences for the dollar and the economy. Raising the debt ceiling would reduce the demand for US bonds, which would drive up interest rates and commodity prices, such as oil and precious metals. It would also fuel inflation, which would complicate the Federal Reserve's plans to raise interest rates.