Will Trump Raise the Roof?
Debates regarding the US debt ceiling are likely to kick into high gear in the coming weeks as the debt-limit suspension expires mid-March.
Scrapping the US debt ceiling will no doubt be absent from President Trump’s list of top priorities for his first 100 days in office, but it perhaps ought to be included. The US is due to hit its debt ceiling in March and if the past two debt ceiling debates are anything to go by, the US will likely face a tough negotiation to suspend or raise the ceiling. This negotiation will fall at a time when President Trump is trying to push through a series of tax cuts and stimulus measures that are central to his platform.
The debt ceiling has for decades been a frustrating restraint on spending that has already been agreed and ratified. The brinkmanship involved in negotiating its increase has led to borrowing costs rising and the downgrade of the country’s credit rating in 2011. This was a problem for a government and markets already in austerity mode, but could pose an even greater challenge to the optimism that has underpinned the markets since President Trump’s election.
Proponents Of The Ceiling
The debt ceiling, as former US Treasury Secretary Jack Lew pointed out in a recent piece, is “a broken, outdated system that no longer meets our country’s needs.” Indeed I recall attending the IMF meetings in Washington DC in 2013 and meeting with European policymakers who, after years of being told to get their fiscal houses in order by the US, channeled a huge degree of Schadenfreude at us as we watched US government buildings shut down over the debt ceiling.
The debt ceiling was largely implemented in 1917 in order to simplify the process of raising money in the US. Up until then, Congress had to meet and approve every single individual debt issuance by the government. This became increasingly onerous as the US had to raise money to finance its role in World War I. Rather than have Congress meet regularly, the debt ceiling was primarily implemented so that the government could borrow to finance spending that had already been agreed, but could not borrow uncontrollably.
The Costs
The debt ceiling made more sense than forcing Congress to approve every debt issuance, but in recent years in particular has been hugely problematic. In both 2011 and 2013 when the US Presidency was controlled by a Democrat but the House of Congress was dominated by Republicans, Congress engaged in brinkmanship over the debt ceiling and risked pushing the US into default.
The US has not defaulted on its debt obligations in well over 200 years. It has the most liquid, deepest asset class in the world in US Treasuries. As a result, the US has benefited from being a safe haven and from having the world’s global currency. This has kept borrowing costs in US Dollars low, and US Treasury yields down.
As Mr. Lew has argued, the debt ceiling drama in 2011 and 2013 directly led to a downgrade of the US credit rating, a decline in stock prices, greater financial market volatility and widened credit spreads. Borrowing costs for the US government rose, as did those for US households and businesses.
Putting On The Brakes For The New Administration?
It is difficult to find anyone who thinks hitting the debt ceiling is positive for the US economy. Should this be a major concern for President Trump, given that we are due to run into the next debt ceiling in March?
That will to a large degree depend on personalities and egos. Don’t forget, after all, that it was House Republicans who refused to raise the debt ceiling in 2011 and 2013 without spending cuts. President Trump campaigned on a platform of tax cuts and infrastructure and defense spending plans, all of which stand to raise the deficit and debt burdens.
If House Republicans stick to their ideology, then President Trump may face opposition when he tries to raise the debt ceiling this year. One might assume that Republicans may have less of a problem spending money when it is one of their own allocating the funds as opposed to a Democrat though. Still, many Republicans would likely claim that Mr. Trump is hardly one of their own; the President is not by most standards a traditional Republican.
Nevertheless, budget hawks interested in their own political futures may decide to support the President when it comes time to raise the debt ceiling rather than sticking to their beliefs. The debt ceiling debate may be the House Republicans’ first chance to show the public how readily they are willing to fall in line with the White House. It may therefore give us a sense of how onerous other policy debates involving spending and taxes could be between the legislative and executive branches of our government.
If budget hawks decide to stick to their guns, there will likely be a swift reaction in the markets. Ever since Mr. Trump was elected, the markets have priced in an acceleration in growth and inflation as well as higher rates as a result of the new government’s proposed stimulus measures. If the government appeared to be careening towards the debt ceiling, the so-called ’Trump trade‘ would likely unwind quickly.
A reversal of the ‘Trump trade’ would likely be bad for the US, but hitting the debt ceiling could be negative for a number of other countries as well.
According to a paper presented at the Jackson Hole Symposium in 2016, roughly 45% of trade is invoiced in US Dollars5. Furthermore, around $10 trillion of foreign debt is denominated in US Dollars6. The US Dollar is the financing and trade currency of choice for a number of emerging market (EM) countries. If the US were to hit the debt ceiling and see its creditworthiness fall, it could spark a balance of payments crisis in EM that in turn could provide a real headwind for US growth.
Change Is Needed
President Trump has mooted a number of bold initiatives, many of which are expansionary. It is typical for politicians to promise policies first and worry about how to pay for them later, after they are elected. Senior members of the House Republicans and the leader of the Ways and Means Committee have demanded that fiscal reforms such as rehauling the tax system be budget neutral. Racking up debt to finance Mr. Trump’s tax and spending initiatives is already likely to be difficult. But it might be brought into the spotlight swiftly in March when the government has to formally raise the debt ceiling.
It seems likely this government will manage to agree to raise the ceiling, but there could be controversy down the line, in another two years when the debt ceiling comes around again. Still, I think federal budget planning is not the kind of bold, attention-grabbing policy that Mr. Trump is likely to prioritize in his first 100 days at the helm of the government. It may not severely restrain his spending plans this time around, but that does not mean it never will.
Discipline is what it takes to block out the noise, commitment is what it takes to walk the path to financial success and patience is what it takes to reach the goal.