Biden’s failure to reach a debt ceiling deal worries world markets

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Joe Biden was meant to be in Australia and Papua New Guinea this week. Instead he had to hurry back to Washington from the G7 to try persuading Republicans to let him raise the US debt ceiling and keep the government afloat rather than agree to stringent cuts.

So what? To outsiders, American debt ceiling brinkmanship can seem dumber than juggling chainsaws; performative and wilfully self-harming even if the very worst doesn’t happen. If the ceiling isn’t lifted by next Thursday the US could go into default, unable to pay its bills or service its bonds.

Flirting with default undermines US debt as a safe haven and the US dollar as a reserve currency. It spooks markets and credit rating agencies and raises the cost of capital.

Actual default could raise unemployment by 5 per cent, wipe 45 per cent off the value of the S&P 500 and cost 8 million jobs in three months, according to the White House’s Council of Economic Advisors. A global recession would probably ensue.

The world has been here before, in 2011, but the long run-in to “X-day” on 1 June is more than ritual. 

• It drags all of each party’s passions into a giant off-diary test of political conviction.
• It leaves the US and world economy at the mercy of two small teams of negotiators, led this time by Congressman Patrick McHenry of North Carolina for the Republicans and presidential counsellor Steve Richetti for the White House. 
• It leaves those teams dependent to a great extent on the radical fringes of their parties.

Madness. The debt ceiling is an arbitrary number reached through political horse-trading that Congress has been required to set since 1917 as an alternative to approving each new tranche of government borrowing individually. It has nothing to do with the budget or debt accountability. Raising it enables the US to pay back money it has already spent, which is why not raising it causes creditors so much anxiety.

Method. Some older congressional Republicans cherish their memories of forcing Obama to the debt ceiling table and thereby paralysing his domestic agenda in 2011, 2012, 2013, 2014 and 2015. Many saw it as retribution for Obamacare and see a similar opportunity to punish Biden now for his $391 billion Inflation Reduction Act, which is 

• creating clean energy jobs under a Democratic administration;
• funding an energy transition that will hurt Republican supporters in the oil and gas sector; and
• creating new corporate entitlements in other sectors, notably electric vehicles.

That IRA. The act is doing something else as well – growing. Its subsidies for EV buyers and battery makers have proved so popular that a recent Goldman Sachs survey estimated the whole package will cost $1.2 trillion by 2032, equivalent to three-quarters of the current US deficit. 

House Republicans want to pare back spending under the IRA, and elsewhere: 

Other cuts proposed by House Speaker Kevin McCarthy and resisted by the White House include scrapping a $400 billion student debt relief plan and shrinking the Internal Revenue Service – which the Congressional Budget Office says would save $80 billion in administration but cost more than $200 billion in uncollected taxes. 

The McCarthy plan would also increase subsidies for oil and gas.

Cui bono? China. It would see downgrades of the nearly $1 trillion it holds in US debt, but, says Marcus Norland of the Peterson Institute for International Economics, it would also see

• a long-run strengthening of the e-Renminbi against the dollar;
• less US power to impose economic sanctions, including on China in the event of war over Taiwan; and
• less US influence at the World Bank and IMF.

Options. Biden’s options include abolishing the debt ceiling and minting a trillion-dollar platinum coin. In reality he will have to deal, and the price will be his agenda. Like his boss 12 years ago, he is hog-tied by the House.