When this money has run out, the Government will only be able to spend the money that it receives in tax. It will therefore no longer be able to meet all of its public spending obligations, such as paying public sector salaries, or service all of its existing debt.
Treasury bonds due in June might not get repaid. This could trigger a financial crisis, says Hunter.
What would happen if the American Government defaulted on its debt?
In theory, if America defaults on its debt, this would send the value of its government debt into turmoil.
The majority (69pc) of US debt is held within America. The Federal Reserve holds 21.2pc, 12pc is in pensions or mutual funds, while US households own 6.7pc.
A further 31pc is foreign-owned. Japan is the largest holder of US Treasury securities, with around $1.1 trillion. China and the UK hold $867bn and $654bn respectively.
But if America defaults, the repercussions would potentially be far larger.
“US Government debt is basically considered the single safest asset in the financial system, and there is a lot of it as well. As a result, a very significant chunk of the price of every other financial asset out there is in some way derived from the price of US government debt,” says Hunter.
If the US defaults, there would be a large spike in borrowing costs in America that would in turn trigger a corresponding rise in borrowing costs around the world, says Hunter.
“Basically, suddenly, every safe asset will suddenly look a lot less safe than it previously did. If that is suddenly at risk of being defaulted on then basically all bets are off in terms of what is going on in wider financial markets,” he adds.
“Failure to reach an agreement at all would bring more severe macroeconomic dislocation given the current scale of the Federal budget deficit and the actions needed to close this quickly,” the Organisation for Economic Cooperation and Development has warned.
A man-made problem
But questions remain over how investors would view a default due to the debt ceiling, because the problem would be entirely man-made.
“The big difference between a potential default resulting from the debt ceiling compared to, say, a default in a country like Argentina which has defaulted loads of times throughout history, is that this would be possibly the only time a country has ever defaulted on its debt essentially out of choice rather than out of economic necessity,” says Hunter.
There is no suggestion that America cannot afford to keep paying its debts, but the Government will be bound by law. “It has created a sort of artificial risk of default,” says Hunter.
America has been even closer to the deadline in the past. Back in 2011, the agreement was passed on the day that the Government was due to run out of money. There was another close shave in 2013.
Previously, when the Government came close to running out of money, although interest rates on Treasury bills that were due to expire jumped, the yields on 10-year Treasury bonds actually fell sharply. “Even with the deadline so close, people still weren’t really thinking there was a genuine chance that the US government would suddenly stop repaying all of its debts,” says Hunter.
The issue was more one of short-term disruption. Longer-term yields fell back, likely on the expectation that interest rates would have to remain lower for longer because of economic weakness and uncertainty, says Hunter.
But the stakes are higher this time. Back in 2011, federal debt was 65.8pc of American GDP. Now, it is 98pc. Interest rates are also much higher. Both of these factors together mean the Government faces much higher debt servicing costs. “In terms of the sustainability of US government finances, this situation is even worse than it was 10 years ago,” says Hunter.
When is the deadline to resolve the crisis?
The deadline is getting increasingly tight. Back in January, when Yellen wrote to House Speaker Kevin McCarthy warning that the debt ceiling would soon be hit, she said it was unlikely that the cash would run out before early June.
But at the start of May, Yellen said the date could be as soon as June 1. At this point, she noted that the actual date “could be a number of weeks later than these estimates”.
If the Government can carry on until mid-June, when its quarterly tax receipts come in, it will get some short-term breathing room, according to The New York Times.
But Yellen has now doubled down on her warning of June 1. In a new letter to House Speaker Kevin McCarthy, she stressed that the buffer was now shortened to “days or weeks”.
The deadline has become so pressing that President Joe Biden has been forced to abandon a trip to the Indo-Pacific for a summit with Australia, India and Japan, as well as a visit to Papua New Guinea.
Can Biden use the 14th amendment?
Biden has made clear that he has been considering using the 14th Amendment – “default is not an option”.
The 14th Amendment refers to a part of the US Constitution, and fellow Democrats are urging the President to use it as a last resort to sidestep the need for a deal with the Republicans.
Section 4 of the Constitution’s 14th Amendment reads: “The validity of the public debt of the United States, authorized by law, including debts incurred for payment of pensions and bounties for services in suppressing insurrection or rebellion, shall not be questioned.”
Some legal experts believe this means it would be unconstitutional for the US to default on its obligations.
That could clear the way for Biden to invoke the amendment and order the Treasury to keep on borrowing beyond the debt ceiling.
“Using this authority would allow the United States to continue to pay its bills on-time, without delay, preventing a global economic catastrophe,” senate Democrats have claimed in a letter to the president.
But the legal interpretation is contested – and it could leave the White House vulnerable to a challenge in the Supreme Court.
Mitch McConnell, the Republican leader in the Senate, is among those who has warned it would be unconstitutional, while even Biden’s Treasury Secretary, Janet Yellen, has admitted it would be “legally questionable”.
White House officials too, while not ruling it out, have played down the prospect of invoking the 14th Amendment.
For now, they are focusing efforts on trying to reach a bipartisan deal.
