With negotiations on the debt ceiling continuing in Washington and the day approaching when the U.S. government may be forced to stop paying some bills, all concerned agree that such a default would have devastating consequences. warned that it would bring
But defaulting on debt may not hurt the U.S. economy.
Even if a last-minute deal is reached, prolonged uncertainty could drive up borrowing costs and further destabilize already volatile financial markets. With the U.S. economy already facing heightened recession risks, it could lead to setbacks in corporate investment and employment, and hamper funding for public works projects.
More broadly, this conflict could have long-lasting consequences, undermining long-term confidence in the stability of the US financial system.
Investors are showing few signs of caution right now. Markets tumbled Friday after congressional Republican leaders declared a “pause” in negotiations, but the drop was modest, with traders still betting that the parties would eventually reach a deal, as they have in the past. It suggests that you are betting on reaching
But investor sentiment could change quickly as the so-called X-date approaches, when the Treasury will be unable to keep paying government bills. Treasury Secretary Janet L. Yellen said that day could come as early as June 1.One thing that has already happened is that while some investors fear that the federal government will default on soon-to-maturity bonds, they started demanding higher interest rates as compensation for greater risk.
Robert Almeida, global investment strategist at MFS Investment Management, said investors could panic if they lost confidence that Washington leaders would resolve their disputes.
“Now that stimulus has waned and growth has slowed, these little little fires are starting to happen,” Almeida said. “It makes an already difficult situation even more stressful. When a herd moves, it tends to move very quickly and violently.”
That’s what happened during the 2011 debate over the debt ceiling. Almost post-default analysis The stock market crash has revealed that $2.4 trillion in household wealth has evaporated, slowing rebuilding and costing taxpayers billions of dollars in interest payments. Credit prices are now more expensive, the banking sector is already reeling, and the economic expansion is slowing rather than starting.
“2011 was a very different year,” said Randall S. Closner, an economist at the University of Chicago and former Federal Reserve official. “We were in recovery mode from the global financial crisis.” Told. “In the current situation with so many vulnerabilities in the banking system, you take more risk. You are building vulnerability upon vulnerability.”
Mounting tension can cause problems through many channels.
Rising federal bond rates will affect auto, mortgage and credit card borrowing rates. This is hurting consumers, who are taking on more debt and taking longer to pay it off as inflation drives up the cost of living. The heightened urgency of headlines could cause consumers to hold off on purchases that underpin about 70% of the economy.
Consumer sentiment is bleak, but the cause is thought to be various factors, such as the recent bankruptcies of three regional banks. Nancy Vanden Houten, senior economist at Oxford Economics, said it doesn’t appear to be spilling over to spending so far.
“I think all that could change when X-dates get closer and there’s real fear that social security, interest on debt, etc. will fall behind,” Vanden Houten said. rice field.
A sudden rise in interest rates would be an even bigger problem for heavily indebted companies. If you have to roll over expiring loans, rolling forward at 7% instead of 4% can throw off earnings projections and lead to a flurry of stock sales. A broader decline in stock prices would further erode consumer confidence.
Even if markets remain calm, rising borrowing costs will drain public funds.Analysis by the Government Accountability Office Estimate The 2011 debt limit conflict increased the Treasury’s borrowing costs by $1.3 billion in fiscal 2011 alone, he said. At the time, federal debt accounted for about 95% of gross domestic product. now it’s 120 percentwhich means the cost of repaying the debt can be even more expensive.
“Ultimately, it will crowd out money that could be spent on other high-priority government investments,” said Rachel Snyderman, senior associate director of the Center for Bipartisan Policy, a Washington think tank. rice field. “That’s where you see the price of brinkmanship.”
Hindering the smooth functioning of federal agencies is already a headache for state and local governments. Many use a US Treasury mechanism known as the “slag window” to issue bonds. Closed on May 2nd It will not resume until the debt ceiling is raised. Public bodies that frequently raise money this way now have to wait, and a prolonged process could stall large infrastructure projects.
There are also more subtle effects that can linger beyond the current conflict. The United States has the lowest borrowing costs in the world because governments and other institutions prefer to hold their wealth in dollars and government bonds, financial instruments that are not considered to be at risk of default. Over time, these reserves are beginning to migrate to other currencies, and ultimately another country may become the preferred port for large cash reserves.
“If you’re a central banker and you’re looking at this, and it’s kind of a repetitive drama, it’s like, ‘We love the dollar, but maybe it’s time to start holding more euros. No,'” said Marcus Noland. Deputy Director of the Peterson Institute for International Economics. “If I were to describe a scenario that falls short of default as ‘Pauline’s Crisis’, it would only push the process further.”
When do these effects really start to increase? In a sense, it only happens when investors move from assuming last-minute deals to predicting defaults at an opaque and unpredictable point in time. To do. But as Standard & Poor’s did in 2011 when it downgraded the U.S. Treasury from AAA to AA+ — even after a deal was reached and the debt ceiling was raised — credit rating agencies have made other There was also the possibility of making that decision because of this, and as a result, the stock price fell. thrust in.
The decision was based on political animosity over the negotiations and the enormous amount of federal debt, both of which have ballooned over the past decade.
It’s not exactly clear what happens if X dates go by without agreement. Most experts say the Treasury will continue to pay interest on debt, instead delaying other obligations, such as payments to government contractors, veterans and doctors treating Medicaid patients.
That would avoid an immediate default by the government, but it could also erode confidence, disrupt financial markets, and lead to a sharp decline in employment, investment and spending.
“These are all defaults, just different groups of defaults,” said William G. Gale, an economist at the Brookings Institution. “If we can do it for veterans and Medicaid doctors, we will eventually be able to do it for bondholders.”
Republicans are proposing a combination of raising the debt ceiling and drastic cuts in government spending. They promised to waive Social Security recipients, Pentagon spending, and veteran benefits. But realizing that equation would require drastic cuts in other programs, such as housing, toxic waste cleanup, air traffic control, cancer research, and other economically important areas.
The Budget Control Act 2011, born out of the 2011 conflict, established a 10-year cap. Progressives criticize For preventing the federal government from responding to new needs and crises.
The economic turmoil caused by the debate over the debt ceiling comes as Federal Reserve policymakers try to keep inflation under control without triggering a recession, a delicate issue with little margin for error. be.
“The Fed is trying to thread a very thin needle,” said Mr. Closner, a former Fed economist. “At some point, you’re going to break your camel’s back. Is this good enough? Probably not, but do you really want to take that risk?”
