Primer on the US Federal Budget and Debt Ceiling Negotiations

The ongoing political wrangling in Congress is the source of bewilderment for many, with even major media outlets getting the federal budget  talks confused with the debt ceiling.Bloomberg is the latest victim, failing to distinguish the difference between the two issues. In essence, budget spending must be agreed by October 1st to avoid a government shutdown, while the debt ceiling must be extended later in October so that the Treasury Department can continue to borrow and honor its sovereign debt obligations.

Budget

The 2013 budget expires at the end of this fiscal year (September 30th) and if a new bill is not agreed upon the US will face its first federal government shutdown in 17 years. The consequences involve hundreds of thousands of federal employees facing furlough (temporary unpaid leave), a possible delay in payment of military personnel and  the closure of national parks and some administrative departments. Of course, members of Congress will be paid as normal.

Last week the Republican-controlled House of Representatives passed a resolution that would fund the federal government until December 15th. However, this bill would deny funding to the Affordable Care Act (Obamacare); a requirement insisted by a group of  uncompromising Tea Party members. The bill is now with the Democratic-majority Senate, which will likely add in the funding for Obamacare before sending it back to the House.

However, it is not clear when the Senate will actually have its resolution ready for the House as several Republicans, and some Democrats, are pledging to use every measure possible to prevent the Senate from restoring Obamacare funding. The measures should  be unsuccessful, but they will likely delay the final vote until late on Sunday (September 29th). That will leave John Boehner and his Republican House colleagues with just a day to decide if they want to anger the Tea Party by allowing Obamacare funding or appease the hardliners by forcing a government shutdown. While the economic impact of a shutdown will be relatively minimal, such a situation will do little to aid the GOP’s fractured image.

Debt Ceiling

Presuming that a budget bill is soon resolved, the focus will turn to the US Treasury’s $16.7 trillion debt ceiling. This will garner much more international attention as failure to extend the debt limit will heighten expectations of a possible sovereign default. Essentially, the Treasury issues billions of dollars in new debt each month to fund various government departments because tax revenue isn’t enough to cover spending. But without a higher limit, the Treasury will be unable to issue enough debt to meet the government’s needs.

Treasury secretary Jack Lew says that by October 17th there will only be about $30 billion to meet the nation’s commitments. This is worrying given that a $60 billion social security payment is due on November 1st. He warns that without sufficient funds the US will fail to meet all of its obligations for the first time in its history. The protracted debt ceiling negotiations in 2011 marked another first as the US debt rating was downgraded from AAA, the highest level. In addition, an agreement was only reached on the condition of spending cuts. And the political situation seems even more divisive now.

Like with the budget bill, funding for Obamacare will be the major point of contention. Boehner says that House Republicans will only vote to raise the debt ceiling if the full implementation of Obamacare is delayed for 12 months. President Obama counters that there will be no negotiations over the debt limit. Ultimately, someone will have to give-in, otherwise US credit-worthiness will be damaged and financial markets will react with gusto.

While prices on US Treasury bonds rose after the downgrade in 2011, market conditions are different today. Prices have been on a downward trend since May, with rates subsequently rising. Even though rates have fallen somewhat in the last week as markets reacted to the Federal Reserve’s tapering delay, they seem set to resume an upward trend when quantitative easing slows. Failure to increase the debt ceiling will add further impetus to rising rates as investors sell their holdings of Treasuries.

The consequence will be higher mortgages and corporate borrowing costs. Moreover, it will see a further deterioration in people’s opinion of the political system as partisan wrangling chokes the fragile economic recovery.

This post also appears on Ronan Keenan’s MacroWatcher blog.