The story so far:

The U.S. Treasury Secretary Janet Yellen notified Congress last week that the country could default on its debt as early as June 1, if the Republican-dominated House of Representatives and President Joe Biden’s White House did not reach a consensus to raise or suspend the debt ceiling.

When the federal government spends more than it brings in, it runs up a budget deficit. It then has to borrow money to meet its financial obligations, accruing debt. The government borrows by creating and selling debt securities like bonds to U.S. investors and companies, banks, pension funds, foreign investors and countries. The largest part of these are owned by the U.S. federal government itself, which keeps the money for social security schemes, medicare, federal pensions and so on. While the administration and Congress decide on taxation and spending, the collection of taxes and the borrowing of funds is done by the U.S. Treasury Department. In 1917, Congress passed the Second Liberty Bond Act, to allow then-President Woodrow Wilson to take out funds for the First World War without waiting for the approval of absent Congress lawmakers. However, the Congress created a limit on borrowing ($11.5 billion at the time), thus creating a debt ceiling that could only be raised by the approval of the Congress (House and Senate).

The U.S. government has hit or come close to hitting the debt ceiling multiple times. According to Treasury Department figures, Congress has acted 78 separate times since 1960 either to permanently raise, temporarily extend, or revise the definition of the debt limit. While the government continues to receive taxation revenue after hitting the debt ceiling, it cannot borrow any more to pay its existing bills. The U.S. would then be unable to pay its debt-holders, resulting in a default.

For starters, the debt ceiling is not a “forward-looking” budgeting instrument, that is, it does not reveal what potentially ideal levels of spending look like. First, Congress approves programmes for which it does not have the entire funding, and then there’s a limit on how much the Treasury can borrow to pay for these already approved programmes. Take this analogy, for instance: if Congress approves $100 of spending, $70 comes from taxes but the cap on what the government can borrow to pay for the rest is fixed at a mere $15.

Another reason why disagreements over the debt limit happen often, almost annually since 2011, is that it has become a political bargaining chip, as any raise or suspension has to be approved by Congress. As American politics becomes increasingly polarised, the Opposition has often used the debt limit as a way of getting budgetary and other legislative concessions. The U.S. came dangerously close to defaulting on its debt in 2011 when the Republicans and the Obama administration could not reach an agreement to hike the ceiling till the last minute. Observers have called the current impasse between House Republicans and the Biden administration even messier than in 2011. The Republican Speaker Kevin McCarthy-led House passed a Bill that pairs a $4.8 trillion in spending cuts with an increase in the current $31.4 trillion debt ceiling. However, Mr. Biden said that he wants a clean debt-ceiling hike and won’t negotiate any kind of cuts, resulting in the current deadlock.

Ms. Yellen and other economists suggest doing away with the debt ceiling, which does not contribute to fiscal discipline anymore and leads to frequent political grandstanding, often at the risk of national and global financial stability.

Analysts say there is no set post-default scenario since the U.S. has never actually defaulted on its debt before. They have warned, however, of a “catastrophic” situation for American and global financial markets. If the government cannot make interest payments to domestic and foreign investors who own its debt securities, it could plunge the globe into a financial crisis, say Wall Street experts. The CFR points out that the “unthinkable” event of a U.S. default could lead to another downgrade of U.S. creditworthiness by agencies, large-scale job losses, weakening of the dollar, stock sell-offs, and a rise in the cost of borrowing for the U.S. government.