US Public Debt and Debt Ceiling USD, tr 15 Since 2000 14 13 Debt Ceiling US Public Debt 12 11 10 9 8 7 6 5 Jan‐00 Aug‐00 Mar‐01 Oct‐01 May‐02 Dec‐02 Jul‐03 Feb‐04 Sep‐04 Apr‐05 Nov‐05 Jun‐06 Jan‐07 Aug‐07 Mar‐08 Oct‐08 May‐09 Dec‐09 Jul‐10 Feb‐11 Why is this graph important? The Federal Government of the United States runs a chronic budget deficit which means the government’s expenditures are consistently higher than its revenues. The gap is filled by borrowing money from the markets, at home and abroad. The borrowed money is added to the debt stock of the country which represents around 92% of the country’s GDP. In order to keep public debt under control, the country sets its own limit to the amount of money it can borrow, and only the Congress can change that ceiling. Usually, raising the limit is not a problematic process, but in this particular occasion the ceiling has become the center of a vivid political fight that risks paralyzing the country. If the debt ceiling is not raised before the country runs out of cash, the payments will need to be prioritized and some will have to be cancelled or delayed. This should make American bonds less attractive, forcing the government to pay higher interest rates. Higher interest rates might affect consumption, economic growth, employment and inevitably the financial markets in US and the world. What does the indicator tell us? The graph shows that the US total public debt has continued to increase uninterruptedly since 2000 and that, consequently, the debt ceiling set by the US Congress has had to be raised ten times in that period. Fiscal trend in the US is worsening in the last years: the government has spent more than it has collected in the last 32 months. This year, the gap has averaged $125 billion a month and the total stock of money owed to creditors amounts to $14.3 trillion, a sum that almost equals the total production of the country in one year. Despite having relatively high debt, the United States usually encounters no difficulties borrowing from the markets as it is deemed safe when it comes to repaying its loans. Still, the US government is expected to run out of cash on August 2nd and, from that day, the Government will not be able to pay off all of its bills. Since the debt ceiling has been reached, the US cannot borrow from the markets unless the Congress, which is in charge of capping and changing the debt limit, approves the raise. What are the economic and financial implications? Historically reaching the debt ceiling does not have important financial implications since the Congress raises the limit almost automatically shortly before it occurs. Not raising the ceiling, when the country is systematically in fiscal deficit, could have significant consequences. First, the government would be unable to cover all its payments. Even though the interest payments on previous loans will be prioritized avoiding a default, hefty federal programs would have to be cancelled. Second, such process would create negative expectations on the capacity of the country to solve its financial woes. Under normal circumstances, such expectations would imply that the US has to pay more to be able to borrow. More expensive American bonds would in turn make mortgages, consumer loans, and capital costs more expensive. This reduces households’ consumption capacity and firms’ profits, depressing economic growth and stock markets. There are some mitigating factors at play, however, that might dampen the impact of rising interest rates. First, international investors looking for a safe country to put their savings do not have many options. Europe is saddled with the Greek crisis and Japan is struggling with the consequences of the earthquake and tsunami. Second, two of the biggest world’s investors in public debt, China and Japan, already own great quantities of American bonds. If the price of these bonds fall, the value of their debt stocks will drop. It is in their interests to keep investing in US treasuries. Still, we expect an agreement to be reached on raising the debt ceiling before the US Government runs out of cash which would be a positive for the financial markets.