When debt ceiling and banking crisis collide

In the United States (US), there is a law that limits or places a ceiling on the total amount of money the Federal Government can borrow to meet its obligations. These include paying for federal employees, the military, social security and interest on the national debt.

The current ceiling stands at approximately US$31.4 trillion. However, periodically, the US Congress votes to raise or suspend the ceiling to allow the Federal Government to borrow more. The ceiling was breached in January this year, but the Treasury Department used extraordinary measures to provide the government with sufficient liquidity to meet its obligations.

The US Congress has never failed to raise the debt ceiling. Traditionally, this was treated as a formality. However, as political schisms widen in the US between Democrats and Republicans, the debt ceiling is increasingly being subjected to the political dysfunction which typifies US politics today.

Congress and the White House have had several meetings on the debt ceiling, however at the time of writing, there appeared to be no consensus on how to prevent the US Government from going into default.

US Treasury Secretary, Janet Yellen, has already warned that a default will create an economic catastrophe. According to Natalie Sherman, a Business Reporter for the British Broadcasting Corporation (BBC), an intentional default would also shock the financial system where more than $500 billion in US debt gets traded every day.

Such a financial shock will reverberate around the world and set back post-COVID-19 economic recovery in the process. The credibility of the US will also take a major hit should it enter into a default.

Meanwhile, the banking crisis which erupted in the US in March this year with the collapse of Silicon Valley Bank (SVB) has not totally dissipated. Since the collapse of SVB, there have been growing concerns about the outlook for mid-size US banks.

At the beginning of May, US regulators seized First Republic Bank (FRB), then sold all of its deposits and most of its assets to the country’s biggest bank, JPMorgan Chase. In March and April alone, three of the four largest bank failures in US history occurred – SVB, FRB and Signature Bank.

Notwithstanding assurances from US financial regulators that the banking system remains sound and resilient, investor confidence in some regional US banks remains low. This was further demonstrated on May 4 when shares of two regional banks – PacWest Bancorp and Western Alliance, fell 51 and 39 percent respectively.

The collapse of Credit Suisse in Switzerland in March this year also sent shock waves throughout global financial markets. While Switzerland is known for banking secrecy, it is also known for banking stability and Credit Suisse’s demise called the latter into question. What happened to Credit Suisse was a wakeup call to financial sector regulators everywhere that there is a potential risk of global financial sector turmoil for which they needed to maintain vigilance.

There perhaps would never be a good time for a US debt default. However, one can hardly think of a worse time than now for such a default.

A US default would likely break the back of the global financial system. As tends to happen with global crises, the smallest and most vulnerable countries will take a disproportionately huge hit and also take a much longer time to recover.

Hopefully, the US political machinery would pull back from the brink of what would be a disastrous default. This would be for the good of not only Americans, but many around the world.

Joel K Richards is a Vincentian national living and working in Europe in the field of international trade and development. Email: joelkmrichards@gmail.com