Default in the USA: Reality or Fiction?

Сurrent Economic Indicators: 

• The U.S. GDP growth rate for Q1 2023 was 1.1%, down from 2.6% in Q4 2022​.

• Personal income increased by 0.3% in March 2023, the same as in February 2023. Consumer spending, however, only increased by less than 0.1%​​.

• The U.S. current-account deficit was $206.8 billion in Q4 2022, a decrease from $219.0 billion in Q3 2022​.

• The U.S. net international investment position was – $16.12 trillion at the end of Q4 2022, an improvement from – $16.84 trillion at the end of Q3 2022​.

• The U.S. monthly international trade deficit decreased to $64.2 billion in March 2023, down from $70.6 billion in February 2023​.

• The U.S. is getting close to the current federal debt limit of nearly $31.4 trillion. If the debt ceiling is not raised, the country could default on its debt, leading to serious global repercussions. 

• The IMF has urged Democrats and Republicans to reach a consensus on this issue. 

• The U.S. Treasury Secretary, Janet Yellen, estimates that the country might hit the debt ceiling by June 1, 2023​​.

Debt Ceiling Situation:

The U.S. government’s ability to fund its obligations is currently a subject of intense debate. The contentious issue lies in the ceiling for government borrowing, also known as the debt limit. As of now, the U.S. debt limit stands at $31.4 trillion, amounting to more than 123% of the annual GDP. Nearly a century ago, in 1917, the U.S. Congress set this borrowing ceiling for the first time. Given that the U.S. government typically spends more than it receives in taxes and levies, a budget deficit is formed, thus necessitating more borrowing and raising the debt limit. Since 1960, this has happened 78 times​​.

The U.S. government funds a significant part of its expenditures through loans, by issuing treasury bonds. Some of the U.S. government’s obligations that are fulfilled through borrowed financing include tax refunds, military salaries, social and medical insurance programs, and interest payments on existing debt. If the borrowing limit is not increased, the Treasury will no longer be able to issue treasury bonds, and the authorities will have to finance expenses only from the incoming income and cash balances​.

The Democrats and Republicans have been unable to reach a consensus on raising the U.S. debt limit. The Republicans demand a significant reduction in government expenditures in exchange for increasing the debt limit, while the Democrats, led by President Biden, insist that the debt limit should be increased without any preliminary conditions​.

Failure to reach an agreement on raising the debt limit could eventually lead the government to default on its obligations, for instance, not being able to make coupon payments on government bonds, leading to a technical default. However, despite the rising debates over the debt limit, the U.S. has never faced a default in its history​​.

Former U.S. President Donald Trump has urged Republican Party representatives to allow a default on U.S. national debt if they fail to achieve substantial budget cuts from the White House. He expressed this view in response to voters’ questions during a Town Hall program on CNN. Trump, however, believes that a default is unlikely as Democrats would agree to reduce federal budget expenses in exchange for raising the national debt ceiling​.

Earlier the same day, President Joe Biden warned of global implications if the U.S. were to default. Biden also highlighted that the risk of default is an “artificial crisis” stirred up by Republicans​​. Most economists have observed that while the probability of a default in the U.S. is very low, Republicans might be willing to risk it to weaken the Democrats​.

On May 9, Biden stated that he does not rule out the possibility of a short-term increase in the U.S. debt ceiling. He also warned that a potential default would be disastrous for the U.S. economy​. A few days earlier, U.S. Treasury Secretary Janet Yellen had cautioned about serious consequences for the American economy if Congress does not raise the debt ceiling. She emphasized that if Congress fails to fulfil its obligations, there are simply “no good options”​​.

In late April, the U.S. House of Representatives passed a Republican bill to raise the debt ceiling by $1.5 trillion and limit future increases in government spending to no more than 1% annually​​. The International Monetary Fund (IMF) has predicted that the U.S. debt level could rise to 125.8% of GDP by 2024, 129.1% by 2025, and potentially reach 136.2% by 2028​. 

This is an ongoing situation, and the negotiations may see changes in the coming days. Notably, market volatility could increase as the deadline approaches, even though experts generally believe that the debt ceiling will eventually be raised, and the U.S. will avoid a default​​.