Will the Americans hit the debt ceiling again?

The US debt ceiling is approaching sooner than expected. If the political parties do not reach an agreement on raising it, the US government may come to a temporary standstill. That does not bode well for the dollar.

In the last century, the American oil magnate John Paul Getty has neatly solved the problem of a very high debt burden: "If you owe the bank $100, that's your problem. But if you owe the bank $100 million, that's the bank's problem." If the financial problems are big enough, there is often a large party that comes to the rescue to prevent a major default from jeopardizing financial stability. A good example is the way in which the Federal Reserve intervened quickly when Silicon Valley Bank suddenly went bankrupt in March. But who will intervene if the American government suddenly can no longer pay the bills?

Ceiling is almost reached
That scenario is less imaginary than it seems. The debt ceiling limit is rapidly approaching in the United States. The debt ceiling was introduced in 1917 to avoid Congress having to sign off on every new government bond issue. Because the debt burden is growing steadily, the ceiling has to be raised regularly. This has happened almost eighty times since 1960. Usually this was done quickly and silently. But a few times the Democratic or (especially) the Republican party used the debt ceiling to force a political change of course from the incumbent government. Without the approval of the Senate and the House of Representatives, an increase will not take place.

2011 as a scare scenario
In 1995 and 2013, certain government institutions came to a temporary standstill because there was no more money to pay salaries. The discussion whether that will happen again soon will flare up in the coming weeks. According to investment bank Goldman Sachs, the debt limit will be reached at the beginning of June. If the Republicans use their majority in the House of Representatives to block an increase in the ceiling, it could have major consequences. In 2011, the debt unrest prompted credit rating agency Standard & Poor's to downgrade the rating of the United States. On August 5, the AAA rating was converted to AA+.

Dollar under pressure
In addition to unrest in the financial markets, this also led to a fall in the dollar against other hard currencies, such as the euro and, in particular, the Swiss franc. In the course of the spring it will become clear how hard American politicians want to play the blame game this time. Incidentally, even without the unrest about the debt ceiling, the dollar is already struggling quite a bit. Due to the shrinking interest rate differential, the currency has lost ground this year compared to, among others, the euro and the British pound. Moreover, the US labor market and industrial sector have started to sputter in recent weeks. But there is also a bright spot: a lower dollar makes a holiday in the United States a lot more attractive.

Joost Derks

Joost Derks is a currency specialist at iBanFirst. He has over twenty years of experience in the currency world. This column reflects his personal opinion and is not intended as professional (investment) advice.

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