The debt ceiling: what happens if the US runs out of money?

Sam Hawley: Hi, I’m Sam Hawley, coming to you from Gadigal Land. This is ABC News Daily. The US economy is in such crisis, President Joe Biden had to cancel a trip here next week. He has less than a fortnight before the nation defaults on its debt, meaning the government would essentially run out of money for the first time ever. Today, economist Louise Sheiner from the Brookings Institution on how America’s fragile political system could drag us all into recession.

Sam Hawley: Louise, it’s pretty unbelievable, what is going on in the US at the moment. The US is in a position where it could default on its debt for the first time in history.

Louise Sheiner: Yes, it is.

Reporter: President Biden and Republicans in Congress are deadlocked over whether the government should be allowed to borrow money.

Chuck Schumer, US Senate Majority Leader: Everyone agreed that default would be the worst outcome. A horrible situation for America and America’s families.

Janet Yellen, US Treasury Secretary: The notion of defaulting on our debt is something that would so badly undermine the US and global economy.

Louise Sheiner: So, I mean, the thing to remember is that the default, if it happens, it’s all about politics, right? It’s not an economic issue. It’s not that we can’t afford to pay our debts. It’s nothing about our economy. It’s about our politics. And so I think we’ve known for a while that our politics is getting pretty dysfunctional, but this is a sign that it might be even worse than we thought. The fact that we’re all actually pretty worried that this could actually happen. So we’re all pretty nervous about it

Sam Hawley: Yeah. Gosh, I bet. So you’d better step us through this because it’s a system we’re not that familiar with in Australia. What is a debt limit?

Louise Sheiner: Okay. So let me explain what it is. So a debt limit is a legal limit set by Congress on how much debt the Treasury can issue, how much the federal debt can be. So what’s crazy about the debt limit law is that the laws about how much is being spent and what taxes are coming in are also written by Congress. So Congress has written laws that say spending is going to be X or you’re going to have benefits that are based on earnings or whatever. They set the rules for the benefit programs. They set the rules for the tax revenues. We know that with those rules, we need to borrow. And yet there’s a debt limit that says you can’t borrow. So we have two sets of laws that are at odds with each other. And it’s kind of a crazy situation, and yet here we are. And when it happens, because it’s so important that we borrow, it’s used as political leverage. You want us to raise the debt ceiling, then you must do X, Y, or Z.

Sheldon Whitehouse, US Senator: The MAGA extremists in the House have presented America with absolutely terrible choices. They have to threaten this way because they know Americans hate what they’re trying to sell.

Sam Hawley: Okay. So sometimes the government needs to lift the debt ceiling, because basically it’s run out of money to pay for the programs that are already in place. Is that right?

Louise Sheiner: Exactly. Like we borrow about 20% of the money that’s going to spending. So about 80% from tax revenues, about 20% from borrowing. So we know we need to keep borrowing, and our debt is going to keep rising over time unless we change the laws. And so any given debt limit, when we hit it, we’re going to need to keep raising it.

Sam Hawley: Right. Okay. And that’s to pay for things like what? Like your armed forces or interest on national debt? It’s sort of, things you can’t avoid paying for.

Louise Sheiner: So to pay for everything, and I think that’s the point, which is that it’s to pay for things like interest on the national debt, but it’s to pay Social Security benefits, public pension benefits, to pay federal employees, to pay for all of our national defence. Like everything, it’s everything. The government spends money on the federal government.

Sam Hawley: But just explain something for me, Louise, because I can see the US officially hit its debt limit on the 19th of January.

Reporter: Today is the day the Treasury Department has projected the Federal government will reach its legal borrowing limit known as the debt ceiling.

Sam Hawley: So it was a while back that it ran out of money. So what on earth has it been doing since then?

Louise Sheiner: So there are things that are called ‘extraordinary measures’ that have been used many, many times in the past. And basically, what they are is, not making certain payments like funding a retirement plan for federal employees. So you just don’t… It’s kind of like not putting the money into your pension plan or something, right? You temporarily don’t put some cash away that you were saving. And then, once this debt ceiling is resolved, they will fund it all. So they have some money that they can basically save legally. And that’s what they’ve been doing. And that’s what we think is going to run out around June 1st.

Sam Hawley: Okay. So June 1st, that’s only a couple of weeks away. So not not long at all?

Louise Sheiner: No, not long at all.

Sam Hawley: Louise, it doesn’t sound like a very stable way of doing things. Why on earth is this system in place at all? What’s the sort of history of it?

Louise Sheiner: So the history actually is this was put in place around World War One. Before it was put in place, every time Treasury wanted to go borrow, they had to go to Congress to get permission. When World War One happened and borrowing increased, it didn’t make sense to have to keep going to Congress. And so basically to lessen the constraints, they’re like, ‘okay, borrow whatever you want, as long as it doesn’t exceed some amount’. And we’ve been we’ve had this debt limit ever since.

Sam Hawley: Now I want you to give me a sense of how much money the government is short of. How much does it need the debt ceiling to increase by?

Louise Sheiner: It depends on how long you want it to be before you have the next debt ceiling crisis, right? I mean, if you look at the projections from the Congressional Budget Office, the debt is projected to just keep rising over time. So it’s at about 100% of our GDP now. And in like 30 years, it’s expected to be close to 200.

Kevin McCarthy, US House Speaker: Our debt is larger than our economy. If we do nothing, we will pay more in interest in the next ten years than we paid in the last 83.

Louise Sheiner: Now, we’ll probably do something about that in the meantime. But it means that the debt is going to keep rising. So if you just raise the debt ceiling by, you know, $1 trillion, you’re going to have to do it again. And so, in my view, the debt ceiling should be raised just, you know, make it three times bigger so that we don’t have to ever worry about this again. But the amount that we need to raise it for one year, we have a deficit of about 5% of GDP every year. So we kind of have to raise it by that amount.

Sam Hawley: I just want you to explain now this problem with raising the debt ceiling, the politics of this, because it’s a common thing to happen, isn’t it? It’s not the first time that a government has had to raise the debt ceiling? But just kind of give me a bit of detail about what’s going on politically here.

Louise Sheiner: The debt ceiling has been raised many, many, many times in history, right, as the debt has increased over time. But it’s not always a big political problem. So it tends to happen when the party in Congress is different from the party in the White House, when everybody everybody’s in the same party, they want to increase spending or they want to cut taxes, they just raise the debt ceiling. It’s really when they want to get it, use it for leverage. And we had a big debt ceiling impasse in 2011.

Barack Obama, former US president: Republican House members have essentially said that the only way they’ll vote to prevent America’s first ever default is if the rest of us agree to their deep spending cuts only approach.

Louise Sheiner: And the result of that when Obama was president was actually a big deal to cut spending over time.

Barack Obama, former US president: Good evening. I want to announce that the leaders of both parties in both chambers have reached an agreement that will reduce the deficit and avoid default, a default that would have had a devastating.

Louise Sheiner: It happened again in 2013. And Obama basically said, I’m not negotiating and kind of won that game of chicken. So we had a debt ceiling impasse in 2021, but that was resolved. And it really always is a game of chicken in some sense. So that’s where we are now.

Sam Hawley: Yeah, I can see that Joe Biden’s point of view is that the Republicans are holding the nation hostage.

Joe Biden, US president: It’s a very extreme wing of the Republican Party. They’re literally not figuratively holding the economy hostage by threatening to default on our nation’s debt unless we give in to their threats and demands.

Louise Sheiner: I think that’s a fair way of describing it. Basically, what you have is a must-pass piece of legislation, and so it gives you a lot of political leverage, but only if you’re willing to actually let the economy default.

Sam Hawley: I can see Joe Biden. He’s in intense negotiations with the Republican House of Representatives Speaker Kevin McCarthy trying to solve this. He’s even cancelled his trip to come to Australia because he really needs to stay on home soil.

Joe Biden, US president: I’m postponing the Australia portion of the trip and my stop in Papua New Guinea in order to be back for the final negotiations with congressional leafders.

Anthony Albanese, prime minister: He was he’s very disappointed at some of the actions of some members of Congress and the US Senate.

Sam Hawley: What are they sort of trying to negotiate? Just tell me a bit about those discussions.

Louise Sheiner: So the Republican House passed a debt ceiling package that was going to cut spending over the next ten years by quite a bit, right? So they passed a package that was really different from what a Biden administration would want. And so now they’re really trying to figure out if there is some middle ground. And Biden for a long time said, ‘I’m not going to negotiate over this, I just want a clean increase without any negotiation’. But at this point, I think he’s negotiating. So the question is whether or not they can find some, I think, relatively small changes in spending that will be good enough for the Republican House to pass that the White House and the Democrats can accept. And that’s a big question, because in the House, in order to become speaker, McCarthy really sort of promised to be quite radical in a way and sort of there are people who are sort of on the more extreme right who sort of gave him his speakership.

Steve Womack, US House Representative: There are still some fractions of the caucus that are having trouble coalescing around this entire bill.

Louise Sheiner: But so it’s a big question. If McCarthy comes up with some compromise that the Democrats can accept, will he be able to get it through the House?

Sam Hawley: Okay. And as you said, the nation’s a little nervous right now. It does seem like a very imperfect system. But what would happen if an agreement isn’t reached? What does that look like, first, for the United States? You know, it is possible that this could lead to a recession in in the United States?

Louise Sheiner: Yes, definitely. But it’s really uncertain, too. And so much will depend on perceptions, right? What happens is the minute that they announce that they are going to be late on a payment or people just say, ‘I’m really nervous about what’s going to happen, so I’m going to pull back on spending’, that’s a possibility. It’s possible that people say, ‘Oh, this is bad, but we knew our politics was bad and maybe they’ll solve it tomorrow or something’. So I think there’s a lot of uncertainty of how bad it is. It’s clear that if it lasts a long time where people actually aren’t getting their cheques from the government, that in itself has direct economic impacts that could cause a recession.

Sam Hawley: If this does happen and we’re not saying it is going to happen, but if it does default, what does that mean for economies around the world, including Australia’s?

Louise Sheiner: If the Treasury market, kind of, implodes, that’s really quite devastating. Do people basically turn away from the United States and say, you know, ‘we’re not going to buy Treasuries anymore, we can’t count on them or we don’t trust the politics in the United States? It’s way worse than we thought, so we’re not going to invest’? I don’t think anybody wants to risk this, right? It’s just so risky, because we know it could be quite devastating in ways that we really can’t even prepare for because we’re not even sure sort of what it will all look like.

Sam Hawley: Dr Louise Sheiner is a senior fellow in economic Studies and a policy director for the Hutchins Center on Fiscal and Monetary Policy at the Brookings Institution based in Washington. This episode was produced by Veronica Apap, Flint Duxfield, and Sam Dunn, who also did the mix. Our supervising producer is Stephen Smiley. Over the weekend Catch ‘This Week’ with David Lipson, where he’ll be looking at calls from the CEO of ChatGPT to better regulate artificial intelligence. I’m Sam Hawley. ABC News Daily will be back again on Monday. Thanks for listening.