- US government could be unable to pay bills in June
- Face-off over energy policy and student loans
Dancing on the ceiling is dancing with the devil as far as US lawmakers are concerned. The ceiling in question being America’s $31.4tn (£25tn) national debt limit, which the Biden administration requires Congressional approval to raise. Barely 18 months from what promises to be a toxic presidential election, the mood is already febrile on Capitol Hill.
A split Congress has led to this crisis – even though Republican gains fell way short of the “red wave” touted in the mid-term elections last year, their slim majority in the House of Representatives has made the Democrats’ better-than-expected showing a pyrrhic victory. Control of the Senate alone isn’t enough to sanction yet more borrowing to fund a policy agenda including clean energy tax credits and the cancellation of student debt.
US presidents have been here before. Bill Clinton had to make concessions to the legislature in the 1990s, likewise Barack Obama in the 2010s. Opining on America’s tragic yardstick for discord, historian and author Shelby Foote once attributed the Civil War to temporary failure of the country’s “genius” for compromise.
Hopefully, nothing so terrible happens this time but brinkmanship could mean a deep economic shock on the back of what was once unthinkable: the US defaulting on its debt obligations.
The latest blow to American prestige
Treasury secretary Janet Yellen warned of stark consequences if agreement isn’t reached between Congress and the White House as early posturing has given way to urgency, with estimates for when the Federal Government can’t pay its bills ranging from early June to mid-July. Even if negotiations are successful at the 11th hour, the rancour compounds many challenges eroding the world’s top superpower.
Wielding the US dollar as a weapon against Vladimir Putin accelerates moves towards de-dollarisation by countries that worry about their assets being frozen. Central banks are more likely to horde gold and diversify their reserves into other currencies, and there have been shifts in bilateral trade such as the agreement for China to use the renminbi to buy Saudi oil.
China took advantage of Putin’s war on Ukraine by becoming Russia’s financial lifeline, getting cheap oil and gas in return. Along with the growing sway over Opec countries (highlighted by Chinese-brokered talks between the Saudis and Iranians) it’s part of a sensible strategy to secure supplies of fossil fuels and pay in renminbi. Furthermore, China is dominant in the procurement and processing of rare earth minerals, which are essential for electrification and the transition to cleaner energy.
By contrast, the US has taken a less circumspect approach than its rival. The Democrats’ pursuit of an aggressive anti-fossil-fuel agenda without alternative generation capacity to pick up the slack left America vulnerable to the shock in global energy markets. For their part, Republicans are intent on repealing the Inflation Reduction Act (IRA) clean energy tax credits as part of a debt ceiling deal, even as global investment piles into the country: the OECD reports that the US enjoyed a world-leading $318bn in foreign direct investment in 2022, much of it encouraged by the stimulus package.
A heady cocktail
Wholesale oil and gas prices have fallen considerably in 2023, along with the cost per gallon of gasoline. Although the residual impact of expensive fuel and fertiliser contributes to high food prices, as a result of cheaper energy the rate of headline US inflation has dropped back to 4.9 per cent. The rate of core inflation, which ignores volatile food and fuel prices, remains stubbornly high at 5.5 per cent.
Despite this, US Federal Reserve Chair Jerome Powell’s softer remarks after the latest interest rate increase (which took the target range to 5 to 5.25 per cent) were taken as a signal that the hiking cycle would soon pause. With a natural delay to the impact of tighter monetary policy, the Fed walks a tightrope between causing an unnecessarily deep recession and the need to get a handle on inflation. Meanwhile, overseas investors who see the value of their dollar holdings eroded if the pause comes too early have turned away from the greenback since the beginning of the year.
Of course, the dollar was at multi-year highs versus a basket of other major currencies, so some retracement was inevitable. This alone isn’t proof of permanent decline, but international efforts to weaken the petrodollar’s grip and conduct more trade in other currencies are only likely to gain impetus from an unprecedented US Treasuries default. That would also cause lasting damage to the greenback’s reserve currency status, upon which rests America’s ability to live beyond its means.
Calling for a reckoning
Given this shaky backdrop, why would Republicans in Congress threaten an act of national self-immolation? They argue that a fiscal reckoning cannot be delayed indefinitely and that playing hardball is the only way to force Democrats to a more sustainable path.
Laying down the gauntlet to Biden at the end of April, Republicans in the House of Representatives passed a resolution including measures such as recalling unspent Covid relief funds and forcing the abandonment of a presidential decree to cancel student debt. In total, the neutral congressional budget office estimates the proposals would save $4.8tn over 10 years. This would be money earmarked for discretionary funding; mandatory spending on things such as Social Security and Medicare would be untouched.
The argument goes that holding back hundreds of billions of dollars would help cool inflation, making it easier for the Fed to pause rate hikes which are straining the financial system: falling bond prices (which move inversely to yields) led to the liquidity failure of Silicon Valley Bank, Signature Bank and First Republic Bank.
Getting inflation back to target and quashing fears of a banking crisis would go a considerable way to boost confidence in America. But gambling with the full faith and credit of the US government – and risking default on a miscalculation – is wholly inconsistent with that goal.
Comments from House of Representatives speaker, Kevin McCarthy (Rep.), suggest a path to avert the crisis will be found, echoing a positive message from President Biden earlier in the week. Welfare-to-work schemes are drawing conservative ire ahead of any deal, but McCarthy and his Republican colleagues must be cognisant that even if they don’t get all they want, this is a chance to set the agenda for 2024 elections and appear stern yet magnanimous – dispelling Democrat slurs of “MAGA extremism”.
After all, as the main incumbents of government, the Democrat Senate and President will cop the blame for general economic malaise going into next year, but if there is a full-blown debt and monetary crisis the American public will apportion blame more widely.
