Less than two weeks after his chaotic ascent, Speaker of the House Kevin McCarthy is already facing down a potential crisis. In a letter sent to McCarthy on Friday, Treasury Secretary Janet Yellen warned that the U.S. is expected to hit its $31.4 trillion debt limit on Thursday, January 19, and outlined a plan to delay the resulting default until the summer.
It is the first such debt limit fight since Republicans took control of the House, and McCarthy has signaled that he plans to leverage the negotiations to secure deep spending cuts, which President Joe Biden and a Senate controlled by Democrats strongly oppose.
Although Yellen appears to have bought lawmakers some time, hitting the limit would prevent the government from making the payments it has committed to and throw the global economy into a tailspin. If McCarthy is not able to wrangle his unruly conference and reach an agreement with Democrats to raise the debt ceiling in the coming months, millions of Americans are likely to face financial hardship.
What is the debt ceiling?
The debt ceiling is the amount of money the U.S. is allowed to borrow to pay for all of its commitments. The U.S. government borrows huge sums of money to cover its expenses. Congress created the debt ceiling decades ago to avoid the hassle of having to approve each new debt individually. Lawmakers have raised the debt ceiling dozens of times since then.
Despite some of the political messaging around the debt ceiling, Congress is not authorizing new spending when it raises it. Instead, lawmakers are allowing the government to take on enough debt to fulfill the spending obligations it has already made. Those expenses include Social Security and Medicare benefits, tax refunds, salaries for government employees, veteran’s benefits, and interest on existing debt.
What would happen if the U.S. defaulted on its debt?
If lawmakers are unable to raise the debt limit in time, the U.S. would only be able to use incoming cash to pay its obligations, which would create a significant shortfall. Every program funded by the government would be at risk.
“Anybody could pick their favorite program,” says Maya MacGuineas, the president of the bipartisan Committee for a Responsible Federal Budget. “Whether someone loves defense spending or food stamps or environmental research, there will be a pause on paying for all of those things.”
Americans who aren’t directly dependent on government payments would also feel the effects if the U.S. defaults. In the past, even flirting with a default has caused economic turmoil. During a battle over the debt ceiling in 2011, the credit ratings agency Standard & Poor’s downgraded the United States’ top credit rating for the first time ever, with stock prices dropping significantly the next business day. The upcoming fight could go even farther, with The Washington Post reporting that House Republicans are preparing a contingency plan for prioritizing payments if lawmakers don’t raise the debt limit in time.
“Failure to meet the government’s obligations would cause irreparable harm to the U.S. economy, the livelihoods of all Americans, and global financial stability,” Yellen wrote in her letter.
The U.S. has never defaulted for failing to raise the debt limit in time, which means the consequences are unpredictable, but economists agree they would be dire. Were the U.S. to actually default, Treasury securities, widely considered to be among the most reliable investments in the world, would no longer be regarded as such, leading investors to demand higher interest rates to loan money to the US government. Those rates would carry over to consumers preparing to take on mortgages, car loans, or credit card debt. Stock prices would likely plummet, causing retirement savings to evaporate. Those consequences would almost certainly trigger a recession. While many analysts were already predicting a recession this year as the Federal Reserve grapples with record-high inflation, a recession set off by a U.S. default could be considerably more severe.
When could the debt limit start affecting Americans’ wallets?
Although Yellen wrote that the U.S. is expected to reach the debt limit on Thursday, the real crisis is likely some months away. That’s because she has invoked “extraordinary measures,” which will allow the Treasury to keep its debt below the limit while it waits for Congress to reach a more permanent solution. In recent years, Treasury secretaries have repeatedly used such measures, which involve temporarily suspending investments in certain retirement savings plans for government employees. Yellen herself used extraordinary measures in August 2021 to help the government avoid defaulting before President Biden signed a $2.5 trillion debt limit increase that December.
In her letter to McCarthy, Yellen predicted that extraordinary measures would keep the government afloat at least until early June. But she also warned that the Treasury is only estimating exactly how long it can continue paying America’s debts.
“The period of time that extraordinary measures may last is subject to considerable uncertainty due to a variety of factors, including the challenges of forecasting the payments and receipts of the U.S. government months into the future,” Yellen wrote.
Barring an unprecedented workaround, Congress will have to vote soon to either suspend or increase the debt limit. With Republicans now in control of the House, that will be easier said than done.
As part of the deal that allowed McCarthy to secure enough votes to become Speaker of the House this month, some right-wing lawmakers have demanded any increase in the debt limit come with deep spending cuts. Others hope to use the issue, a rare must-do item on the legislative agenda, as a bargaining chip to enact conservative policies. McCarthy said Tuesday he hoped to begin negotiations with other leaders and the president as soon as possible. But congressional Democrats and the White House say they will insist on a no-strings-attached debt limit increase.
“This is not political gamesmanship,” Karine Jean-Pierre, the White House press secretary, told reporters on Friday. “This should be done without conditions. And that’s how we see this process moving forward.”
As it has in the past, a protracted stalemate could hurt the economy in the lead up to the debt ceiling deadline, even if lawmakers eventually reach an agreement. With both sides digging in their heels, the stage is set for another drawn-out congressional standoff in the months to come.
“I’ve seen very few deals that are difficult that Congress has done in advance of when they need to,” MacGuineas says. “I think nobody’s going to want to compromise until they feel that they have no other choice but to do so. Instead, I think we will do this at the last minute possible with all sides acting as though they’re unwilling to compromise, which is the very crux of governing.”