January 09, 2023
Beating the Debt Ceiling Drum
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Below is a transcript of this week’s video:
Looking ahead into 2023, one of the more daunting tasks that this new divided Congress is likely to face will be to either raise or suspend the country’s debt ceiling in order to prevent a default on federal government debt. Currently, the national debt sits at $31.3 trillion, roughly $98 billion away from reaching the federal limit of $31.4 trillion. While the U.S. government may not be at risk of default until the second half of the year, the debacle over the House of Representatives speakership perhaps forebodes difficulty for consensus-building in Washington on the issue.
The last time this sprang up as such a contentious issue was in late 2010, 2011 timeframe. Now between 2008 and 2010, Congress raised the debt ceiling from $10.6 trillion to $14.3 trillion. Then in 2011, as the economy showed early signs of recovery and federal debt approached its limit once again, a heated debate ensued. Through this tumultuous time, the stock market was thrown into frenzy in the lead-up to and aftermath of the 2011 debt limit debate, declining nearly 20% from the top of the market to the bottom in October. The concern here is if talks break down this year, this could lead to market volatility.
U.S. national debt remains high and has grown significantly over the last decade particularly as a % of U.S. GDP. However, currently, debt service costs as a percent of U.S. GDP are manageable, sitting at roughly 1.6%. But there is a consideration on how long the cost will remain manageable. The U.S. Treasury issues debt with various maturities, ranging from one month to 30 years. Currently, approximately half of the outstanding debt is set to mature within the next three years. While some of this debt has already been reissued at higher interest rates, the overall effect on net interest paid on borrowed funds as a percentage of gross domestic product is expected to increase significantly over the next decade due to the recent rise in prevailing Treasury yields.
As the U.S. national debt is projected to continue growing over the next decade, according to projections from the Congressional Budget Office, this increase in debt could potentially pose a risk to economic growth. Interest costs are expected to become a larger percentage of the federal budget, and net interest as a percentage of GDP is projected to nearly double by 2030. This may lead to a potential reduction in funding for other government initiatives and/or higher taxes in the future. But for now, material risks to the economy due to fiscal policy do not appear imminent.
In order to track how the markets are assessing the risk of default is the credit default swaps, or CDS for short. These are essentially financial derivatives that pay out in the case of a qualifying credit event such as nonpayment of interest. As it stands now, the CDS market reflects low risk at this point, particularly as compared to previous spikes like during the financial crisis in 2008 or the debt ceiling crisis in 2010, 2011.
In summary, one major issue the new Congress may have to confront in the second half of 2023 is the debt ceiling, which could prove difficult under divided control. Higher interest costs and less tax revenue are likely to add to the pressure on government fiscal policy in 2023 and beyond. Not all interest payments will rise immediately, since roughly 50% of government debt does not mature within the next three years. Although rising rates will gradually lift net interest costs for the federal government, those costs are still estimated to remain under 3% of GDP through 2030. Still, each round of debt ceiling debates provides an opportunity for fiscal brinkmanship to accelerate these risks.
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