The US has reached its debt limit: What does this mean and what comes next?

Washington: The United States hit its borrowing cap of $31.4 trillion Thursday, prompting the start of measures to avoid a default as Democrats and Republicans head towards another clash on raising or suspending the country's debt limit.

Treasury Secretary Janet Yellen said her department would turn to resources from two funds for retirees as part of the "extraordinary measures" it started using to give the government some room to continue to function.

Here is what you need to know about the situation:

Is the US in default?

The short answer is no.

The debt limit is a legally established maximum on how much the United States can borrow to pay the government's bills, for everything from social welfare programs to salaries for the military.

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Once the ceiling is reached, the Treasury begins to draw down cash balances and use accounting techniques that allow the government to continue operations, said Mickey Levy of Berenberg Capital Markets.

The threat of a default surfaces once these temporary measures are exhausted, which the Treasury said is likely around mid-year.

"The period of time that extraordinary measures may last is subject to considerable uncertainty," warned Yellen in a letter Thursday.

How serious could this be?

Failing to raise the debt limit would have dire economic consequences, according to the Treasury, as it would lead the government to an unprecedented default.

Treasury Secretary Janet Yellen said her department would turn to resources from two funds for retirees as part of the 'extraordinary measures' it started using to give the government some room to continue to function. AFP

There could be a shutdown of some government functions, and even approaching a breach of the limit could roil markets.

For now markets remain calm, with Edward Moya of trading platform OANDA noting the process regularly "goes down to the wire."

A default would hurt the United States' credibility and global standing, and investors could ask for higher interest rates to lend money to the government, adding to authorities' payments.

Not meeting the government's obligations "would be catastrophic for America's working families and lead to higher costs," warned Senate Majority Leader Chuck Schumer on Tuesday.

Why is there a gridlock?

Congressional lawmakers have found themselves gridlocked over raising the debt limit, an issue that has increasingly sparked contentious debate in recent years.

Republicans, who control the House of Representatives, are calling for spending cuts in exchange for support in raising the debt ceiling.

But President Joe Biden has said he would not negotiate with Republicans who threaten to use the debt problem for leverage, saying it should not be "political football."

The new speaker of the House, Republican Kevin McCarthy, called it "a sign of arrogance if you say you wouldn't even discuss it."

The situation points to a heightened chance of an extended stand-off. The government has previously come close to a default over gridlocks on funding.

Is a default likely?

"The probability of government default on its debt is close to nil," Levy said. But the battle over raising the limit could become protracted.

Since 1960, Congress has acted 78 times to permanently raise, temporarily extend, or revise the definition of the debt limit. This has happened under both Republican and Democratic presidents.

The US economy could face severe disruption with Republicans threatening to refuse the usual annual rubber-stamping of a rise in the legal borrowing limit, and this could push the United States into default. AFP

Even if political manoeuvring brings a partial government shutdown, "various budgetary work-arounds will allow the government to continue servicing its debt, conducting basic services including defence, and providing funding for Social Security and entitlement programs," Levy said.

What is the Treasury doing?

The Treasury said it would be unable to fully invest a portion of the Civil Service Retirement and Disability Fund, with a "debt issuance suspension period" to last until early June.

Treasury will also halt additional investments of amounts credited to the Postal Service Retiree Health Benefits Fund, Yellen added.

But she stressed "federal retirees and employees will be unaffected by these actions" and the funds will be "made whole" once the impasse is over.

There have been calls to end the legal limit in recent years, with analysts calling the brinksmanship unnecessary.

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