Home Business NewsBusiness Why the US debt ceiling really matters and what it means for inflation

Why the US debt ceiling really matters and what it means for inflation

by LLB Reporter
11th May 23 9:52 am

The US stock market is doing well, the benchmark US ten-year government bond yields are barely flickering, and the dollar is barely changed from a year ago, so markets appear unconcerned about the imminent US debt ceiling. But such confidence could be seen as complacency, because the issues behind America’s borrowing mountain are fundamental for the global economy and asset prices.

Yes, it would be an act of gross stupidity by Republicans and Democrats alike to let America suffer a ninth government shutdown, let alone default, and as such it seems likely the debt ceiling will be raised for the forty-seventh time since 1980. But even if common sense does break out, the question of how America will fund and manage its debt going forward will remain.

AJ Bell investment director Russ Mould said: “Investors – and politicians – can be forgiven for believing that a compromise will ultimately be found on Capitol Hill and the Democrats and Republicans reach an agreement that raises the debt ceiling. After all, this is a relatively common occurrence.

In addition, failure to reach a deal on a new debt ceiling could lead to three immediate repercussions.

“First, the US government would shut down and perform only vital services to protect people and property. Staff would not be paid, nor welfare payments distributed, in a repeat of similar (thankfully brief) interludes in 1981, 1984, 1986, 1990, 1995, 2013, 2018 and 2019.

“Second, that could hit US economic growth at a time when the outlook is uncertain.

“Finally, the US could, conceivably, default on its debt, as interest payments to bondholders would also cease. America could look to prioritise handing over the coupons, but putting cash payments to overseas investors ahead of the interests of US citizens is unlikely to be a vote winner – a key consideration when the next Presidential election is just 18 months away.

“Even a brief interlude could plausibly increase the coupon the US has to pay going forward when it wishes to sell bonds to investors.

“As such, a deal to raise the debt ceiling is the most logical course of action, even allowing for the acts of political brinkmanship which May could witness, and Treasury Secretary Yellen is doing her best to cajole the two parties to come together.

“This may be because she is looking at how US government tax receipts have fallen year-on-year in each of the last five months even as spending has continued to rise.”

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