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The debt ceiling deadline is late July – Democrats have options but no clear plan yet

The U.S. Capitol is reflected in a rainwater basin on Capitol Hill in Washington, D.C., United States on Monday, March 23, 2020.

Al Drago | Bloomberg | Getty Images

An upcoming vote in Congress on raising or suspending the federal debt ceiling will become the newest political minefield for Democratic leaders as they work overtime to work out massive spending and infrastructure bills in the weeks ahead.

A two-year suspension of the 2019 debt ceiling is slated to expire later this month, and Democrats appear to have no strategy yet to raise or re-suspend the limit to new heights.

"We're considering all options," House spokeswoman Nancy Pelosi, D-Calif., Recently told Bloomberg News when asked about the Democrats' strategy.

Republicans, meanwhile, seem poised to revive the debt ceiling wars they waged during the Obama administration after four years of relative silence over the debt ceiling hike under GOP President Donald Trump.

If an agreement to raise the debt ceiling falls victim to gambling and procrastination, the consequences could be devastating.

If the current two-year suspension is not extended or a new, higher ceiling is not exceeded before the August break in Congress, it could jeopardize the fragile economic recovery and have serious consequences for workers and businesses alike.

While the United States has never defaulted on its debts, recent history shows that uncomfortable proximity to chaos can lead to chaos. In 2011, House Republicans' refusal to approve a debt ceiling hike resulted in a downgrade in the credit rating of US Treasuries, which angered financial markets.

Still, the political rationale in Congress about raising the debt ceiling is extremely difficult as members of both parties are reluctant to cast votes that could be seen as contributing to the massive national debt.

"Everyone knows it needs to be increased except for the most demagogic officials," said Tom Block, policy strategist at Fundstrat Global Advisors. Still, "it is one of the most politically claimed votes that many members take."

For lawmakers, voting is often a delicate balance between incurring fiscal responsibility in the next elections and avoiding generally recognized economic upheaval.

For Pelosi, the risk is in the parliamentary elections in 2022.

Not only does it need to raise enough votes to pass a debt ceiling suspension, but it also needs to protect its razor-thin majority as the House of Representatives Democrats in the swing districts are likely to face major challenges. The President's party usually loses seats in the House of Representatives between election terms.

Republicans are at risk in the 2022 primaries. While the GOP will quickly curb Democratic spending in the general election, any Republican who votes to suspend the cap faces a right-wing attack from an even more fiscally conservative rival.

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In 2019, Congress voted to suspend the debt ceiling until July 2021. Votes on the suspension of the debt ceiling tend to be more palatable to members of Congress than votes that raise the limit to new heights because the votes on the suspension are not numbered.

But that 2019 suspension expires later this month, after which the Treasury Department will not be able to raise additional cash through the sale of bonds, subject to a new vote.

Unless the debt ceiling is raised, the Treasury Department must begin using emergency accounts to pay the government's bill.

And with unprecedented spending thanks to the Covid-19 stimulus, Treasury Secretary Janet Yellen has warned that she may not be able to sustain that emergency life juice very long before it hits the all-important "drop-dead" date that the government would trigger a technical requirement.

Known strangers

The timing of that drop-dead date is a matter of guesswork, however, as economists have no precise information about how much cash the Treasury Department has and how much it spends each day paying the nation's bills.

While the US has never defaulted before, economists see this outcome as a doomsday scenario and a significant threat to several sectors of the American economy.

“The US, which goes back to George Washington, has never defaulted on its debts. So that would set a pretty dangerous precedent, ”said Michael Feroli, US chief economist at JPMorgan.

In an extreme situation where lawmakers cannot reach an agreement after the drop-dead date, lenders around the world could demand higher interest payments from Uncle Sam.

This could create a domino effect that will force interest rates across the U.S. economy – from mortgages and auto loans to corporate debt rates – to jump in sympathy.

Yellen and her staff have remained silent to emphasize the urgency of the 2021 vote as pandemic-era spending eases. She warned senators in June that given the historic spending, the Treasury Department could use up its emergency funds much sooner than in previous years.

"It is possible that we could get to this point while Congress expires in August," she said, referring to the legislature's annual summer recess. "I think sovereign debt default should be seen as unthinkable."

U.S. Treasury Secretary Janet Yellen testifies before the Senate Financial Services Subcommittee on the Treasury Department's financial application for fiscal year 22 on Capitol Hill in Washington, DC, June 23, 2021.

Shawn Thew | Swimming pool | Reuters

"I think it would start a financial crisis: it would threaten American jobs and savings at a time when we are still recovering from the Covid pandemic," she added. "I would ask Congress to simply protect the full faith and creditworthiness of the United States by raising or suspending the debt limit as soon as possible."

The mere specter of national bankruptcy can have a significant impact on markets.

In 2011, the deadlocked Republicans of the House of Representatives and Obama's White House came within days of one circumstance.

The S&P 500 fell five days in a row before lawmakers finally struck a deal. That sell-off shed 4% off the market index and was the worst week in more than 12 months.

The rating agency Standard & Poor & # 39; s downgraded US debt securities from AAA to AA + for the first time in the country's history.

A default "could cause all kinds of chaos in the financial markets," Feroli said. "Part of this chaos is known, but it is the unknowns that worry people very much about the technical failure."

The JPMorgan economist added that business contracts often require collateral from non-defaulting companies, which previously included government bonds.

"If the Treasury's collateral is no longer permissible, it would really pull the rug out from under the financial system," he said.

Permanent political danger

However, Feroli and others are not worried about Washington's solvency.

The real risk is that political aspirations for the 2022 election cycle will prevent Yellen from paying the government's bills on time.

And that's because very few politicians, whether Democrats or Republicans, like to be viewed as advocates of ever-increasing public debt, even if government spending is otherwise popular.

Republicans, for example, have stood up to billions of dollars in the past for the military and the agribusiness they represent. Democrats are currently looking for trillions to help support families, expand paid family vacation programs, and make college more affordable.

To make matters worse this year, Congressmen from both parties are looking to find a compromise on a trillion dollar infrastructure deal and the Democrats are trying to balance multiple competing interests within their faction.

A successful infrastructure deal would mean lawmakers could take a break later this year and show voters how much federal funding they have secured for the district's roads, bridges, and broadband.

The debt ceiling, on the other hand, is the opposite: a vote with no tangible benefit for the voters, but much downside if their opponents accuse them of wanting to inflate national debt in the next year.

Three options

In the coming weeks, House spokesman Pelosi will be faced with three options, each of which carries risks.

The first option would be to put an increase in the debt ceiling into the massive reconciliation bill that the Democrats intend to pass later this year.

The benefit of this strategy would be that the rest of the bill would likely distract voters from the unpopular vote on the debt ceiling hidden in the thousands of pages of legislation.

The risk, however, is that negotiations on this Democratic-only law will last well into September and possibly even into October.

Given Yellen's drastic warnings about the Treasury's limited ability to tap into emergency government funding, tying the debt ceiling to the Atonement Act could be tantamount to playing roulette on America's creditworthiness.

The second option would be to set up a stand-alone vote to either suspend or raise the debt ceiling.

The advantage of this strategy would be that the borrowing limit is not tied to a tricky adjustment calculation.

But stand-alone votes to raise the debt ceiling are deeply unpopular with ordinary members, and Pelosi would likely be rejected by her caucus if she tried to call such a vote.

The US House of Representatives Speaker Nancy Pelosi (D-CA) stands with members of the Democratic Women & # 39; s Caucus (DWC) during a press event on the care industry at the US Capitol in Washington on July 1, 2021.

Jonathan Ernst | Reuters

There is a third option: instead of raising the debt ceiling, Democrats could try to suspend the ceiling for another year, either through a stand-alone vote or as part of an independent bill.

The advantage here? Avoiding a tough vote to raise the national debt limit was made difficult by the meager majorities of the Democrats.

The disadvantage? A year-long suspension would have to pass both houses, and the Senate's 60-vote threshold means Republicans could delay passing the bill until they get concessions from the Democrats on a number of other issues.

When asked for comment on the story, a spokesman for Senate Majority Leader Chuck Schumer, D-N.Y., Referred CNBC to the Senator's remarks in May.

"You know, I think it's an absolute shame that Republicans use the debt ceiling, which deals with financial security, as some kind of political issue," Schumer said at the time. "We should be doing something right."

A spokesman for the House of Representatives office did not respond to CNBC's request for comment.

Voting is not child's play for Republicans either. While Democrats are often criticized for their spending, GOP members are vulnerable to similar attacks from challengers in their own party during the primaries.

"There are a lot of Republicans watching over their shoulders," said Block, Fundstrat's policy strategist. "They know they are running the risk that a Republican opponent will win a primary campaign against them as an irresponsible donor."

Representatives of the Senate Minority Leader Mitch McConnell, R-Ky., And the House Minority Leader Kevin McCarthy, R-California, did not respond to CNBC's request for comment.

Block insists that the Democratic leadership will attempt to include the debt ceiling in a major bill, such as the current infrastructure contract.

That approach, he said, not only allows Republicans to save face by offering them a reason to vote in favor, but also puts pressure on progressive Democrats who might otherwise ask even more of an infrastructure plan that the Excludes financing climate change or social programs.

"It's just really difficult to substantiate the obvious structural imperatives of increasing your member's policy," Block said. "The main concern of almost every employee is to get their member elected and to save their job."

– Thomas Franck reported from New York and Christina Wilkie from Washington.

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