WEEKLY E-MAIL

23 May 2023

THE U.S. DEBT CEILING AND POTENTIAL IMPACT ON AUSTRALIA’S ECONOMY

By Jonathan Toh

What is the U.S. debt ceiling?

The U.S. debt ceiling was first introduced by Congress in 1917 to allow for some control over government spending and dictates the maximum amount of money the U.S. federal government can borrow to meet its debt obligations. Over time, the ceiling is raised or suspended depending on inflation, GDP growth and budget deficits.

Currently, the debt stands at around US$31.4 trillion (AUD$47.4 trillion). To put this in context, Australia’s total gross domestic product (GDP) is US$1.6 trillion (AUD$2.4 trillion).

The current situation

According to the U.S. Treasury, the overall public debt of the U.S. has already surpassed the debt cap as of January 2023. The U.S. Treasury has taken “extraordinary measures” to continue paying bills, including tapping into its cash reserves and halting the reinvestment of securities in investment and public benefits programmes.

According to Treasury Secretary Janet Yellen, the U.S. will likely reach the default date by June 1 if the debt ceiling is not raised.

Negotiations to raise the debt limit are ongoing, but there are disagreements between the House of Representatives and the White House on how to proceed. Democrats think Congress has a duty to raise the debt limit, but Republicans would not agree to an increase until Democrats agree to slash spending.

What happens if the U.S. defaults, and how will this affect Australia?

Although the Democrats and Republicans will likely agree to raise the debt ceiling if an agreement cannot be met, the consequences of a default on the global economy and markets will be devastating, unleashing a worldwide recession, the freezing of credit markets, and global mass unemployment.

The White House Council of Economic Advisers estimates a shrinkage of up to 6.1% in the economy could happen if an agreement is not reached for an extended period.

Moreover, there will undoubtedly be a flow-on effect on the rest of the world, including Australia. Senior Economist Rabobank Ben Picton noted, “If there’s a U.S. default, it affects everybody because the United States or U.S. bonds are the cornerstones of global financial markets, and the U.S. dollar is the world’s reserve currency”.

AMP chief economist Shane Oliver noted, “Global recession would mean less demand for our exports, lower commodity prices, and less export earnings generally.” And “It would also be a blow to confidence in Australia, so it could tip us into recession as well.”

What’s next?

Presently, the Democrats and Republicans will need to establish a common ground. The widespread consensus is that the debt ceiling will be increased or suspended to provide more time for negotiations before a default occurs.

According to Robert Abad from Western Asset, the probability of a default by the U.S. is very low. Still, if it did, it would cause equal, if not greater, volatility than the 2008 global financial crisis.

Jonathan Toh
Associate Financial Planner
Authorised Representative No. 1284667

If you have any questions or comments, please email me at jonthan@gfmwealth.com.au

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