Han Dieperink: Debt ceiling deadline is approaching

October 31, 2023

^{This column was originally written in Dutch. This is an English translation.}

By Han Dieperink, written in a personal capacity

Within three weeks, a polarized US Congress must reach an agreement, otherwise the government will be shut down. This time, the impending closure coincides with important monetary policy decisions, elections and geopolitical tensions.

Before 1917, the United States government could only make government loans if they were approved by Congress. However, the Second Liberty Bond Act of 1917 provided that the government could take out as many government bonds as necessary to finance the government. Congress was only allowed to determine the maximum amount of the debt.

The Second Liberty Bond Act was motivated by special circumstances. Due to the First World War, the government had to borrow a lot and procedurally the situation was unworkable. To prevent excesses, a debt ceiling was imposed. But since 1917, the debt ceiling has been raised about 80 times.

Republicans vs. Democrats

Over the past three decades, raising the debt ceiling has become increasingly difficult. American politics is becoming increasingly polarized. An agreement on a higher debt ceiling is no longer self-evident. In particular, the combination of a Democratic president and a new Republican majority in Congress regularly provides fireworks.

After the 1994 midterms, Democratic President Bill Clinton faced Republican majorities in both the House of Representatives and the Senate. This Republican revolution sought to achieve budget balance as part of the 'contract with America'. Clinton had to reduce spending, but blocked this with a veto.

Then this fight continued through the debt ceiling. The US government closed its doors for five days. Speaker of the House Newt Gingrich even threatened a default for the first time in history. If Clinton were not to give in to Republican demands, he said, this would be a risk. In the stalemate that followed, the American government closed its doors for 21 days.

After the 2010 midterms, Democratic President Barack Obama faced a Republican majority in the House of Representatives. Under the influence of the Tea Party, Republicans once again aimed for a balanced budget. Ahead of the debt ceiling deadline, the S&P 500 fell 17% and interest rates rose. Based on this stalemate, Standard & Poors lowered the credit rating of the United States from AAA to AA+.

The Budget Control Act of 2011 was signed just before the deadline. Spending fell by $917 billion in ten years and the debt ceiling rose by $2.1 trillion. The debt ceiling came into view again during the discussion about the Affordable Care Act (Obamacare) and the government closed again for 16 days. Now, 12 years later, Fitch has also lowered the rating for the US to AA+.

Polarization is increasing again

Given the increasing polarization, a higher debt ceiling seems an unattainable goal. But both parties must realize that the blocking party usually does not sit well with voters. Thanks to the blockade in the mid-1990s, Clinton won the 1996 election. In 2011, the Republicans got their way, but they could not benefit from it electorally.

The current crisis resembles those of 1995 and 2011. The difference is that the small majority of Republicans in the House does not exactly provide more stability. For example, fifteen rounds of voting were needed to select the last speaker of the house. Yet last week, Republican Mike Johnson from the Trump camp relatively quickly became the new speaker of the house. This reduces the chances of a debt ceiling crisis.

Johnson must ensure that a deal on the debt ceiling is reached within three weeks. To do this, Johnson must negotiate with a Senate in which the Democrats have a majority. The consensus in Washington is that Johnson will not be able to reach an agreement with the Democrats within three weeks. The alternative is an extension of the negotiations. However, such a measure is precisely the reason that the last speaker-of-the-house Kevin McCarthy had to leave the field. It is possible that he will nevertheless manage to postpone everything until early 2024.

Geopolitical tensions

Another dilemma is that the Republicans have an electoral tailwind due to the terrorist attacks in Israel. Not only is Donald Trump now almost certainly the Republican candidate, he is also ahead in the opinion polls. Joe Biden just hit a new low with an approval rate of just 37%.

Biden appears to have bet on the wrong horse with his friendly approach to Iran. In that respect, he must hope for the recent questionable development in public opinion. As long as Jews are victims, public opinion can deal with that just fine. But as soon as they strike back, that sympathy quickly disappears.

Part of the debt ceiling is also the Biden administration's request for $ 106 billion in military aid to Ukraine, Taiwan and now Israel. Although there is broad support for Israel among both Republicans and Democrats (the House of Representatives condemned the attacks by 412 votes to 10), some Republicans are starting to cry about the support for Ukraine. Johnson now wants to split that request into two parts.

The trump card that the Democrats hold is that the five-year farm bill (which mainly benefits Republican states) must be extended and this requires support from the Democrats.

For financial markets, the approach to the debt ceiling deadline on November 17 could bring more volatility. An additional problem is that when the government has to close its doors, macroeconomic figures are no longer published. That means the Fed is operating in the dark at a crucial time. Furthermore, this could be the moment that the Democrats lose the next elections and that markets therefore have to price in another four years of Trump.

More columns by Han Dieperink