A deal to raise the United States’ $31.4trn debt ceiling before the country runs out of money is about to face its first test in Congress.

President Joe Biden has urged Congress “to pass the agreement right away” to “prevent the worst possible crisis – a default for the first time in our nation’s history”.

The House of Representatives Rules Committee is ]due to consider the 99-page bill at 3pm local time on Tuesday, ahead of votes in the Republican-controlled House of Representatives and the Democrat-controlled Senate.

Both the Democratic President and the top Republican in Congress, House Speaker Kevin McCarthy, have predicted they will get enough votes to pass it into law before Monday when the US Treasury Department says it will not have enough money to pay the bills.

We take a look at the US debt crisis and what happens if it defaults.

What is the debt ceiling?

The debt ceiling – also known as the debt limit – is the maximum amount of money the US can borrow to pay its bills, from social security and Medicare benefits, to military salaries and interest payments on outstanding national debt.

The US issues bonds to raise money to finance its operations.

If US national debt reaches that ceiling then the Treasury Department must implement measures to pay government obligations and expenditures until the ceiling is raised or suspended through a congressional vote.

The current US debt ceiling is $31.4trn; the government hit that borrowing limit in January.

Since then, the Treasury has used what is known as “extraordinary measures”, which entail moving funds around and freeing up cash for the government in the short term.

The debt ceiling has been raised or suspended numerous times over the years to avoid the worst-case scenario: a default – when a borrower fails to fulfil its obligations to the creditor.

FILE PHOTO: President Joe Biden shakes hands with House Speaker Kevin McCarthy of Calif., after the State of the Union address to a joint session of Congress at the Capitol, Tuesday, Feb. 7, 2023, in Washington. Jacquelyn Martin/Pool via REUTERS/File Photo
President Biden reached the deal with House Speaker Kevin McCarthy (Photo: Jacquelyn Martin/Reuters)

What is in the new deal?

The new agreement, reached by President Biden and Mr McCarthy on Sunday, would suspend the debt ceiling for two years.

It would keep non-defence spending roughly flat in the 2024 fiscal year and increase it by 1 per cent the following year, past the next presidential election.

Overall, the White House estimates the plan would reduce government spending by at least $1trn but official calculations have not yet been released.

It would also speed up the permission process for some energy projects, claw back unused Covid-19 funds and introduce work requirements for food aid programmes for some Americans.

And it would stop the pause in student loan repayments by the end of August.

What must be done to avoid default?

The bill will have to clear the rules committee first, however.

Mr McCarthy said on Monday he was not worried that the committee would kill the bill.

A successful vote by the committee would then pave the way for a vote by the full Republican-led House on Wednesday.

If passed, it would then go to the Democrat-majority Senate for a vote which could possibly stretch into the weekend if senators try to slow its passage.

But if finally agreed, it would suspend the US debt limit until 1 January 2025, allowing President Biden and lawmakers to set aside the politically risky issue until after the November 2024 presidential election.

NEW YORK, NEW YORK - MAY 30: Traders work on the floor of the New York Stock Exchange during morning trading on May 30, 2023 in New York City. The stock market opened slightly high amid the Biden administration and Republican lawmakers reaching a tentative deal on raising the U.S. debt ceiling in order to avoid a default, with Congress prepared to vote on the legislation as early as Wednesday. (Photo by Michael M. Santiago/Getty Images)
Missing a payment on US bonds could trigger a Wall Street meltdown, says one economic analyst (Photo: Michael M. Santiago/Getty Images)

What happens if the US defaults on its debt?

If the US Congress and the White House failed to lift the self-imposed $31.4trn legal limit on federal debt, the Treasury Department could start missing payments on its obligations on 5 June, according to the Treasury chief, Janet Yellen.

Washington would be under severe pressure to keep making payments on US bonds, which underpin the global financial system.

Missing a payment could trigger a Wall Street meltdown of historic proportions. “It would be downright cataclysmic,” said Mark Zandi, an economist at Moody’s Analytics.

Even if the Treasury pays bondholders on time, the political dysfunction driving this crisis could sow distrust in America’s economic prospects, and the value of everything owned by Americans, from homes to their retirement portfolios, would drop.

“Stock prices would fall, commercial real estate values, house prices. Everything would fall,” Mr Zandi said.

Interest rates would increase, making it harder to buy a home or car or borrow money to start a business and within days, according to Mr Zandi, the financial mayhem would put the economy on the path to recession.

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