Idiot’s guide to US debt ceiling

2011-08-06 08:53

Republican and Democratic leaders in the US have reached a tentative ­agreement on raising the US debt limit and ­avoiding default. The deal was ­approved by both houses of Congress on Monday.

But what does this all mean in ­simple terms? Below are some basic questions and answers on the issue.

What is the proposed deal?
Under the agreement, the US deficit will be reduced by at least $2.4?trillion (about R16.45 trillion) over 10 years. The ceiling for US ­borrowing will be raised by about the same amount in two stages, to $16.7?trillion.

What is the debt ceiling?

There is a legal limit on the total amount of debts the US government can run up in order to pay its bills.

The current limit is $14.3?trillion, which was reached in May.

US Treasury Secretary Timothy Geithner was able to extend the ­expected day of reckoning to August?2 by various tricks such as postponing payments into government pension schemes and better-than-expected tax revenues.

Why can’t the Obama administration borrow more?

Because it is not in Obama’s power. The debt ceiling is set by statute and can only be raised by Congress.

An overall borrowing cap was first introduced by Congress in 1917 to make it simpler for the government to finance its efforts in World War I.

Since then, the ceiling has been raised dozens of times, and it is ­usually a formality.

Perversely, Congress also sets the government’s spending commitments and tax-raising powers.

This puts the Obama administration in the impossible position of being ­required to spend more than it earns, while also being prevented from ­borrowing the difference.

What is the problem this time around?
The financial crisis and the US’s fragile economic condition have caused ­government spending to soar, while tax revenues have suffered. This has caused a big rise in the government’s deficit and its borrowing rate.

What have been both sides’ ­positions?
Both sides accept that cutting the deficit is vital. In recent weeks, several plans have been proposed.

The chief sticking points were ­Republicans’ resistance to tax rises and calls for much bigger spending cuts than the Democrats favour; and Democrats’ desire to shield healthcare programmes for the poor and elderly, and the Social Security pension ­programme from cuts.

A number of House Republicans, mainly newly elected staunch Tea ­Party fiscal conservatives, oppose raising the debt limit in any form.

What would have happened if no deal was reached by August 2?

The US would have been in default, something Geithner said would be “catastrophic”, and Obama had warned could tip the US back into ­recession.

What do academics believe would have happened if the US defaulted?
Interest rates on credit cards, car loans and home mortgages were likely to rise sharply, says George Washington University Professor Julius ­Hobson. Global financial institutions across the world holding AAA-rated US Treasury notes and bonds would have seen the value drop.

Harvard economics Professor ­Jeffrey Miron says foreign creditors could have started withdrawing money from US banks, and cheques to social ­security beneficiaries would have been delayed.

Surely the US would not default on its debts?
So far that has been everyone’s ­assumption. The US has not seen any significant increase in its borrowing cost in the way that Greece and other indebted eurozone governments have.

The rating agencies were somewhat less relaxed. On July 15, Standard and Poor’s warned it could cut the US’s coveted AAA credit rating if no deal was done, which could limit some ­investors’ ability to lend to the US.

Some analysts also pointed out that a surprisingly large amount of existing debt comes up for repayment in this year – some $1.7?trillion, or 12% of its total debt. They feared that investors could panic and refuse to relend the money, forcing a default.

– BBC


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