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Debt Ceiling Crisis: Default or Not, Reveals Precarious Foundation of Economy

Isaac Nuriani    |
Jan 27, 2023
  • Think tank calls U.S. fiscal outlook “unsustainable.”
  • Debt-ceiling crisis: Increase may just delay the inevitable.
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For the 79th time since 1960, the federal government has reached the debt ceiling.[1]

The debt ceiling represents the legal limit – currently $31.4 trillion – on the amount of debt the government can accrue. Congress must vote to raise that legal limit. Raising the debt ceiling would allow the government to make good on obligations it already has incurred. Notably, it’s not a vote to take on new obligations, which come by way of the annual budget and appropriations process.

However, the debt ceiling often is not summarily raised without incident and instead becomes the focus of a standoff – as it is now. The reason is that fiscally prudent Washington politicians can use a refusal to raise the debt ceiling as a way to attempt to force an agreement on future spending cuts.

The ongoing battle over the debt ceiling is likely to continue for some time this year. According to Treasury Secretary Janet Yellen, the government can use accounting tricks – “extraordinary measures” – to keep the government running and meet principal obligations until around early June.[2] By then, if the ceiling has not been raised, the United States will begin defaulting on its obligations – something it has never done before in history.

As the battle over raising the debt ceiling plays out, Americans could miss a bigger point – in my opinion: namely, that regardless of whether or not the ceiling is raised, the nation’s economy is now precariously positioned on a foundation of massive debt, and as long as it is, risks to the stability of both the domestic and global economies will continue.

We don’t have to look back very far in history to see how economic volatility resulting from world economic risks has the potential to cause great harm to U.S. households. A 2019 Bankrate survey found that roughly half of Americans had seen no improvement in their financial situation nearly 12 years after the Great Recession unfolded.

In fact – according to that same survey – nearly 25% of Americans were worse off.[3] Experts say it’s possible that volatility arising if our national debt becomes unmanageable would be more substantial than even that generated by the Great Recession.[4]

Default or not, the nation has an enormous debt problem, and it’s likely to grow. It could, therefore, be in the best interests of retirement savers to make sure they own assets with the potential to protect their accounts from the damage.

I’ll talk about one example of assets like that later on. First, let’s look a little closer at the consequences analysts say are likely to arise if the debt ceiling isn’t raised – or even if it is.

Policy Analyst: Debt Default Like “Detonating Bomb in Global Financial System”

If it turns out the debt ceiling is not raised in time for America to avoid defaulting on its obligations, the consequences could be enormous.

The reason the consequences would be so severe is that the entire world – and the world’s credit markets – rely on the stability of the U.S. economy and our government-issued debt. A default would send shockwaves throughout the global community as confidence in America’s financial stability erodes.

Interest rates on Treasury securities would soar as borrowers demand higher rates as compensation for their heightened risk. Even with higher rates, demand for Treasuries likely would sink anyway as investors in U.S. debt doubt the government’s commitment to making good on them.[5]

Because Treasury rates underpin the rates U.S. consumers pay for homes, cars, student loans, credit cards and more, all of those rates would also rise – at a time when the nation already is teetering on the edge of recession.[6]

Besides higher interest rates, a 2021 analysis by Moody’s Analytics suggested the nation probably would suffer a variety of additional direct consequences, including:

  • A decline in real GDP of 4%
  • Six million jobs lost, translating to an unemployment rate close to 10%.
  • Equity-market losses of more than one-third of their value, translating to tens of trillions of dollars wiped from household net worth.[7]

Moody’s also suggests that interest rates likely would stay elevated even after a resolution to the default crisis because of the new and likely lasting perception that Treasury securities would no longer be risk-free instruments.[8]

Of course, some significant impacts might be immediate. Social Security payments, Medicare payments and veterans’ benefits payments, for example, could be suspended right away, says a White House report on “life after default.”[9]

It’s reasonable to assume a default also would send shockwaves throughout the global community as confidence in America’s financial stability quickly erodes.

Jacob Kirkegaard, a senior fellow at the Peterson Institute for International Economics, summarizes the global consequences of a U.S. debt default this way:

The U.S. Treasury market is the world’s anchor asset. If it turns out that that asset is not actually risk free, but that it can actually default, that would basically detonate a bomb in the middle of the global financial system. And that will be extremely messy.[10]

That mess likely would include significant volatility to global financial markets and paralysis of global credit markets. Worldwide recession would result.[11]

The very status of the U.S. dollar as the world’s reserve currency could be at stake in a default. Challenges to the dollar’s status as dominant reserve currency have intensified in recent years, particularly from Russia and China.[12] Right now, that dominance remains great enough that the dollar’s position as top dog is not in jeopardy. But if the U.S. defaults on its debt, some speculate it could prompt other nations to look more seriously at increasing their reserves of competing currencies, including China’s renminbi.[13]

It seems obvious that a debt default could impact retirement savers’ holdings. Could the same be said even if the debt ceiling is raised without (much) incident?

Let’s look at that side of the debt-ceiling coin now.

Think Tank: “U.S. Faces an Unsustainable Fiscal Outlook”

An increase or suspension of the debt ceiling would cue a collective sigh of relief. That sigh of relief might even be breathed by some deficit hawks, who know that forcing a default is filled with risks even though it might yield a benefit (reduction in future spending).

As it turns out, though, avoiding a default without gaining a solid commitment of spending cuts could lead to problems with debt manageability down the road anyway. Raising or suspending the limit means it would be “full speed ahead” once again in racking up ever-higher debt totals. According to experts, some of the most profound consequences that could result from a default today could still be realized sometime in the future if the national debt is allowed to continue rising without restraint.

According to the CRFB, “the United States faces an unsustainable fiscal outlook” right now. Their recent projections suggest that the portion of federal debt held by the public could represent nearly 140% of gross domestic product (GDP) in just nine more years. What’s more, interest alone on the debt could reach 4.4% of GDP by that time. The CRFB points out that interest on the debt has never exceeded 3.2% at any time in American history.[14]

Looking out over a longer period, the most recent calculations of the Congressional Budget Office (CBO) say the public’s share of the federal debt could equal nearly 200% of GDP by 2052, and that interest alone could be a little more than 7% of GDP by then.[15] Note, however, those calculations were made in the first part of 2022; it now is anticipated that the next round of projections issued by the CBO will suggest an even more ominous future debt burden.[16]

As for the potential consequences of such a burden, there are several, according to the CBO. Among them are more protracted impacts, such as slower economic growth and higher interest payments to foreign investors in U.S. debt. But the most significant potential consequence is a major fiscal crisis that could arise from debt unmanageability.[17]

So if the debt approaches the unsustainable level foreseen by the CBO, it suggests investors would fall into a crisis of confidence about the government’s ability to meet its obligations. Among the possible ramifications, the CBO says, would be higher interest rates resulting from investors’ expectation that bigger yields would offset the greater risk associated with owning that debt.[18]

In such a scenario, higher rates could catalyze higher inflation – and even notable dollar weakness.[19]

The unfolding fiscal crisis could quickly morph into a financial crisis, according to the CBO. As rates jump for Treasury instruments, the value of outstanding government securities would decline – maybe sharply. The financial institutions holding those securities – pension funds, mutual funds and systemically important banks, to name just a few – could suffer losses large enough to cause failure. The financial crisis would quickly become worldwide in scope.[20]

In other words: Even if the nation avoids nearer-term debt default, it’s not out of the realm of possibility that retirement savers eventually could face the same consequences anyway.

 

 

……..
[1] Home.Treasury.gov, “Debt Limit” (accessed 1/26/23).
[2] Greg Iacurci, CNBC.com, “A debt ceiling standoff may trigger ‘serious’ fallout for Americans, warns economist. Here’s what it means for you” (January 18, 2023, accessed 1/26/23).
[3] Sarah Foster, Bankrate.com, “Survey: Nearly 1 in 4 American adults are worse off now than before the Great Recession” (June 13, 2019, accessed 1/26/23).
[4] Ayelet Sheffey and Juliana Kaplan, Business Insider, “We could soon be facing the biggest financial crisis in history as Republicans threaten to stop paying America’s bills” (January 19, 2023, accessed 1/26/23).
[5] Committee for a Responsible Federal Budget, “Q&A: Everything You Should Know About the Debt Ceiling” (January 18, 2023, accessed 1/26/23).
[6] Ibid.
[7] Mark Zandi and Bernard Yaros, Moody’s Analytics, “Playing a Dangerous Game With the Debt Limit” (September 21, 2021, accessed 1/26/23).
[8] Ibid.
[9] WhiteHouse.gov, “Life After Default,” (October 6, 2021, accessed 1/26/23).
[10] Rob Garver, VOANews.com, “5 Ways US Debt Default Would Echo Through Global Economy” (September 30, 2021, accessed 1/26/23).
[11] Iacurci, “A debt ceiling standoff may trigger ‘serious’ fallout.”
[12] Ananya Kumar and Josh Lipsky, Atlantic Council, “The dollar has some would-be rivals. Meet the challengers.” (September 22, 2022, accessed 1/26/23).
[13] Garver, “5 Ways US Debt Default Would Echo.”
[14] Committee for a Responsible Federal Budget, “New Projection: Federal Debt Will Reach Record Levels Sooner Than Expected” (November 16, 2022, accessed 1/26/23).
[15] Congressional Budget Office, “The 2022 Long-Term Budget Outlook” (July 2022, accessed 1/26/23).
[16] Preston Brashers, The Heritage Foundation, “Unhappy New Year: CBO Forecasts Poor Economy, Soaring Deficits in 2023” (December 13, 2022, accessed 1/26/23).
[17] Congressional Budget Office, “The 2022 Long-Term Budget Outlook.”
[18] Ibid.
[19] Ibid.
[20] Ibid.
[21] London Bullion Market Association, “Precious Metal Prices,” (accessed 1/26/23).
[22] Teaganne Finn, NBCNews.com, “Yellen warns of ‘catastrophe’ if Congress doesn’t handle debt ceiling issue” (October 10, 2021, accessed 1/26/23).
[23] Ron Elving, NPR.org, “Why we have a debt ceiling, and why this trip to the brink may be different” (January 21, 2023, accessed 1/26/23).

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