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The U.S. has hit its debt ceiling. How could Canada be impacted if a deal isn’t reached?


A political battle is brewing in the United States over a self-imposed cap on federal borrowing — and experts warn Canada’s economy may not be immune if the stalemate isn’t resolved.

U.S. Treasury Secretary Janet Yellen alerted lawmakers last week that the country would hit the debt ceiling, currently set at US$31.4 trillion, on Thursday. Now that the day is here, Congress has until early June to reach a deal on either raising or suspending the limit to avoid defaulting on the national debt, Yellen said.

“Failure to meet the government’s obligations would cause irreparable harm to the U.S. economy, the livelihoods of all Americans, and global financial stability,” she wrote in a letter to congressional leaders.

Republicans, who now control the House of Representatives, have said they plan to push for government spending cuts before agreeing to further raising the debt ceiling. The White House has said it will not negotiate such a compromise, setting up a potentially bruising standoff with Democrats that could drag on for months.

While previous debt ceiling fights have been resolved, the concern north of the border is that this time is different.

“Whatever happens in the U.S. has huge consequences here,” said Kristen Hopewell, a public policy professor at the University of British Columbia’s School of Public Policy and Global Affairs.

“We can certainly hope that the two sides will reach a resolution and avert catastrophe. But there’s no guarantee that that will happen, especially with how they are playing this game of chicken.”

What is the debt ceiling?

First introduced in 1917 to help pay for the First World War, the debt ceiling limits how much money the U.S. government can borrow in order to meet its spending requirements.

If the ceiling is hit, it means the government can no longer pay its bills, which would send it into default. Federal employees and contractors may no longer be paid, and an economic crisis could explode.

Moody’s Analytics warned in 2021 that a default would be “cataclysmic” and “devastating,” forecasting a GDP decline of nearly four per cent, a one-third drop in U.S. stock prices and close to six million jobs lost.

Congress, which legislates government spending, has the power to raise the ceiling and has done so dozens of times. Occasionally, more protracted fights have broken out — including during the 1990s, when Republican House Speaker Newt Gingrich squared off twice with President Bill Clinton in 1995 and 1996.

The most dramatic standoff before this year was in 2011, when more conservative Republicans aligned with the Tea Party movement refused to budge on the debt limit unless future government spending was cut.

The impasse dragged on for so long that the U.S.’s credit rating was briefly downgraded for the first time in history and stock markets downturned. Canada wasn’t immune from the volatility: the loonie wobbled against the U.S. dollar and commodities suffered.

Despite reaching a deal to limit future spending just two days before the U.S. was due to default, far-right Republicans tried again in 2013, this time targeting the Affordable Care Act. Since then, the debt ceiling has been raised or suspended repeatedly.

What’s different this time?

The current standoff actually starts from a similar place as 2011: far-right Republicans, angry over Democratic spending, are pushing for significant spending cuts before agreeing to any further raising of the debt ceiling.

The difference now is how much power that Republicans have in a narrowly divided Congress. Nearly two dozen members of the Republican caucus held up House Speaker Kevin McCarthy’s election for days until he agreed to their demands, including a more aggressive posture on spending.

Another difference is the sheer amount of debt being talked about. In 2011, the debt ceiling stood at $14.3 trillion — less than half the current threshold.

McCarthy and other Republicans have likened the debt ceiling to a credit card limit, explaining that just as an individual or household with credit card debt would change their spending behaviour, so too should the government.

While Republicans have long focused on getting cuts to federal entitlement programs like Social Security, Medicare and public health care, White House press secretary Karine Jean-Pierre on Tuesday warned that border security, drug enforcement efforts and even school lunch programs could also be on the chopping block.

None of that spending will be negotiated, she told reporters: “This is something that should be done without conditions.”

“There is no excuse for political brinksmanship when American jobs and economic safety is on the line.”

Democrats in the House and Senate have focused on the economic consequences a default would bring if the debt ceiling is not raised, signalling they too will not approve such spending cuts.

Yellen told lawmakers on Thursday the treasury still has “extraordinary measures” it can use to keep the government afloat until early June at the latest. Those include divesting some payments, such as contributions to federal employees’ retirement plans, in order to provide some headroom to make other payments that are deemed essential.

Although she urged Congress to “act promptly” and find a solution, McCarthy has signalled he is focused on negotiations.

“We are six months away, approximately,” he told reporters at the U.S. Capitol on Tuesday. “I would like to sit down with all the leaders, and especially the president, and start having discussions.”

Is Canada worried?

As the clock begins to tick, economists and political watchers in Canada are mixed on whether it’s time to start panicking yet.

“There’s a bit of unease in the markets right now,” Derek Holt, vice-president of Scotiabank Economics, said in an interview. But he added that signs of concern over a potential U.S. default are “not really something I think the market is treating seriously at this point.”

Notes shared by economists at the Bank of Montreal have acknowledged the debt ceiling fight as a “possible landmine” that could stall the continued efforts to fight inflation in the North American economy.

The bank’s chief economist, Doug Porter, noted last week that he cited the potential crisis as a reason Canada’s economy may have a stronger recovery than the U.S. economy while speaking at the Economic Club of Canada.

Holt added that Canada could potentially stave off any impact due to its relatively low deficit-to-GDP ratio compared with other countries, as well as strong commodities.

But Hopewell says Canada, like most every other country that relies on the American market, “will not be immune” from any spillover effects of a protracted crisis. She adds that Canada’s overall economic reliance on the U.S. causes particular concern.

“Trade makes up a big share of our GDP and about three-quarters of our exports go to the U.S.,” she said.

“We’re so integrated economically … that we would be hit extremely hard.”

Prime Minister Justin Trudeau did not appear worried when asked about the issue in Windsor, Ont., on Tuesday.

“Canada will always work to make sure that we are able to weather any storm that the United States deliberately or inadvertently throws our way,” he said.

“We continue to watch closely what’s going on in the United States. But we’re going to make sure that Canadians continue to succeed regardless of what happens down there.”

Finance Minister Chrystia Freeland’s office pointed to Trudeau’s comments when asked by Global News if the minister has discussed the standoff with her American counterparts, and if the government was making plans to counteract any impacts.

A spokesperson for the Bank of Canada told Global News the central bank could not comment on any contingencies it may have in place ahead of next week’s expected key rate announcement.

Other Canadian experts are similarly skeptical that a crisis will occur.

“It’ll never happen,” University of Toronto economic professor Laurence Booth said in an email. “No party wants to be known as the party that voted in spending then refused the funding and caused the U.S. bond rating to drop.”

Even McCarthy seemed to acknowledge on Tuesday he may not be able to hold out forever.

“Who wants to put the nation through some type of threat at the last minute with the debt ceiling? Nobody wants to do that.”

Source : Global News