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With the debt ceiling issue resolved, another catastrophe waits on their doorstep...


What is Debt Ceiling ?

Consider it as a credit limit but for the government.


With this credit limit now extended, the government is able to raise more funds, so that is a good sign right ?

Well yes and no!


Yes because the government is out of the risk of defaulting.

And No because of the following factors :


US treasury is currently under a deficit of 1.1 Trillian dollars!


To make up for the deficit and raise capital again, the government has to issue bonds which is like borrowing money.

But the current state of the economy is not as it was in the previous years. With inflation at it's peak and rising interest rates, the condition of the economy has deteriorated significantly.

As a reason, the government will not be able to sell their bonds cheap, like they used to previously. To attract public and big financial institutions to subcribe to their bond issue, they will have to offer higher interest rate. This would increase the interest costs they will have to pay in the future.


But there is one bigger problem, that is Liquidity!


Liquidity as we know, is the backbone of the economy.

And when the goverment issues bonds, they essentially suck this liquidity out of the system. This creates a void in the system that can trigger a chain reaction of events like:

  1. Credit Crunch - By subscribing to government bonds, banks essentially use up their reserves, which means that they can lend less to the general public, which leads to a higher interest rate.

  2. Cash Crunch - Institutions will face difficulties in meeting their financial obligations and maintaining the stability of their portfolios.

  3. Market Meltdown - With higher bid-ask spreads, market movements will become erratic and volatility will rise significantly.





 

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