What is the debt ceiling?

THE US debt ceiling, created in 1917, sets the maximum amount of money that the federal government can borrow. As the US typically spends more than it collects, its government must borrow huge sums to plug the budget deficit. 

President Joe Biden’s administration and congressional Republicans have been scrambling to strike a deal to raise the country’s US$31.4 trillion debt ceiling. If they bust the deadline, a historic default will occur, as soon as Jun 1. 

Such an event would hurt the US economy and rattle global markets, in what Biden has described as “unprecedented and potentially catastrophic”. Americans would lose their jobs, and the economy would tank, crushing imports and world trade.

The default would ripple across the world – equity markets would tumble, interest rates would spike, US dollar-borrowing costs would spiral, and global growth and recovery would stall.

Will the US lose its AAA rating?

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Ratings agency Fitch has put the US’ top-tiered “AAA” rating on a negative watch in a precursor to a possible downgrade if the country does not raise or suspend its debt limit on time. 

Should this happen, Fitch said it would give a “negative signal of the broader governance and willingness of the US to honour its obligations in a timely fashion”, which would be inconsistent with an “AAA” rating. 

Moody’s, which has an “Aaa” rating on the US government with a stable outlook – the highest creditworthiness ranking it gives – said it was “confident” a default would be averted. But if it happens, the “Aaa” rating would go out the window. 

In 2011, a similar debt ceiling standoff led S&P Global to lower its US credit rating from AAA to AA+, its second-highest tier. The agency has since kept the rating at this slightly lower level. A downgrade of America’s credit rating would be disastrous for global financial markets as foreign countries hold trillions of dollars in US treasury bills. The US dollar is also a global reserve currency, accounting for almost 60 per cent of the reserves held by the world’s central banks. Thus, any dent on the US’ credit ratings and its currency will have major repercussions on markets and governments’ coffers.

Flight to quality

In Singapore, analysts are also monitoring developments closely.

Some noted that the continued uncertainty could ironically strengthen the US dollar and weaken the Singdollar in the near term. This is because the US dollar – commonly known as the “King” dollar – is a haven for investors, even when the crisis itself originates in the US.

An Asia-Pacific currency strategist explained that with extended market uncertainty and volatility, currencies such as the greenback and Japanese yen are favoured over Asian currencies like the Singdollar.

This flight to quality was played out in 2008 during the US real estate market crisis.

Among Asian currencies, the Singapore dollar itself has “some safe-haven properties”, which could also result in “a possible short US dollar/Singapore dollar”, that is, investors selling US dollars and buying Singdollar instead. 

Beyond stocks, bonds and currencies, Singapore businesses would also be hurt by a rout in the US economy and the broader financial markets. The Republic is an export-oriented economy, and the US is its third-largest trading partner. Additionally, a fall in US imports from China and the rest of the world will also flow back to hit Singapore’s exports further. Needless to say, market watchers are still hopeful for a deal. They said disaster can be averted if a deal is cobbled together at the eleventh hour. But if a default does happen, some are of the opinion that markets will bounce back if the event doesn’t last more than a day or two.