‘Financial Armageddon.’ What’s at stake if the debt limit isn’t raised
Updated 1503 GMT (2303 HKT) September 8, 2021
New York (CNN Business)The easiest way to spark a financial crisis and wreck the US economy would be to allow the federal government to default on its debt. It would be an epic, unforced error — and millions of Americans would pay the price.
And yet that unlikely situation is once again being contemplated. If Congress doesn’t raise the limit on federal borrowing the federal government will most likely run out of cash and extraordinary measures next month, Treasury Secretary Janet Yellen warned lawmakers on Wednesday.
In short, a default would be an economic cataclysm. Interest rates would spike, the stock market would crater, retirement accounts would take a beating, the value of the US dollar would erode and the financial reputation of the world’s only superpower would be tarnished.
“It would be financial Armageddon,” Mark Zandi, chief economist at Moody’s Analytics, told CNN. “It’s complete craziness to even contemplate the idea of not paying our debt on time.”
In her letter to Congress, Yellen said history shows that waiting “until the last minute” to suspend or increase the debt limit “can cause serious harm” to business and consumer confidence, raise borrowing costs for taxpayers and hurt America’s credit rating. “A delay that calls into question the federal government’s ability to meet all its obligations would likely cause irreparable damage to the U.S. economy and global financial markets,” Yellen wrote.A US default would undermine the bedrock of the modern global financial system.
“We pay our debt. That’s what distinguishes the United States from almost every other country on the planet,” Zandi of Moody’s said. Because of America’s long track record of paying its debt, it’s very cheap for Washington to borrow. But a default would force ratings companies to downgrade US debt and shatter that borrowing advantage. Markets plunged in 2011 when that debt ceiling standoff caused Standard & Poor’s to downgrade America’s credit rating.Higher borrowing costs would make it much harder for Washington to borrow to pay for infrastructure, the climate crisis or to fight future recessions. And refinancing America’s nearly $29 trillion mountain of existing debt would become that much more expensive. Interest expenses, which totaled $345 billion in fiscal 2020, would quickly rival what Washington spends on defense.
Soaring Treasury rates would set off a chain reaction in financial markets. That’s because Treasuries, viewed as risk-free investments backed by the full faith and credit of the federal government, serve as the benchmark by which virtually all other securities are measured.Everything from stocks and bonds to exotic securities take their cues from Treasuries. A spike in Treasury rates sparked by a default would cause booming stock markets to become unglued.”Stock prices would crater,” Zandi said. “We’d all be less wealthy, instantaneously.”
Not only would millions of Americans lose money in the stock market, but it would suddenly become more expensive for families and companies to borrow. That’s because Treasuries serve as the benchmark for mortgages, car loans, credit cards and corporate debt. A spike in borrowing costs is a huge problem for an economy that relies on access to credit.If the debt ceiling is not lifted, then the federal government will technically default on some of its obligations. It would be forced to prioritize payments, deciding who will get paid and who won’t.Ultimately, someone will lose out, whether it’s federal employees, veterans, Social Security recipients or defense contractors.For all these reasons, investors are not freaking out about the debt ceiling. Wall Street expects Washington will eventually raise borrowing limit, like it always does. Failure to do so would simply be too dangerous.
Read the rest of the article: https://edition.cnn.com/2021/09/08/business/debt-ceiling-default-explained/index.html
*Nov 30, 2020 article but highly relevant.
US Debt Default Causes and Consequences
Will the U.S. Ever Default on Its Debt?
Reviewed by Eric Estevez Updated November 30, 2020
America has never defaulted on its debt. The consequences are unthinkably dire. But in October 2013, Congress threatened to stop raising the debt ceiling, forcing the nation into default. It wanted the president to cut spending on Obamacare, Medicare, and Medicaid.
The debt ceiling is how much debt Congress allows the federal government to have. If the ceiling is not raised, the U.S. Treasury Department cannot issue any more Treasury bonds. Its ability to pay bills depends on the revenue that comes in. It’s forced to choose between paying federal employee salaries, Social Security benefits, or the interest on the national debt. If it doesn’t pay interest, the country defaults.
At the last minute, Congress agreed to raise the debt ceiling, but the damage was done. During the three weeks that Congress debated, investors seriously wondered whether the United States would actually default on its debt.
This was the second time in two years that House Republicans resisted raising the debt ceiling. The consequences of a debt default may become all too real in the very near future. The country had, at the end of 2019, about $23.2 trillion debt or $70,492 per U.S. citizen.1
- If investors lose confidence in U.S. Treasurys, it creates uncertainty in the financial markets.
- U.S. Treasurys affect interest rates and the cost of lending.
- A U.S. debt default would wreak havoc on the global economy.
- America should lower its debt or face economic hardships
How the United States Could Default on Its Debt
There are two scenarios under which the United States would default on its debt. Any default on Treasurys would have the same impact as one resulting from a debt ceiling crisis.
Not Raising the Debt Ceiling
Default would occur if Congress didn’t raise the debt ceiling. Former Treasury Secretary Tim Geithner, in a 2011 letter to Congress, outlined what would happen.2
- Interest rates would rise, since “Treasurys represent the benchmark borrowing rate” for all other bonds. This means increased costs for corporations, state and local government, mortgages, and consumer loans.
- The dollar would drop, as foreign investors fled the “safe-haven status” of Treasurys. The dollar would lose its status as a global world currency. This would have the most disastrous long-term effects.
- The U.S. government would not be able to pay salaries or benefits for federal or military personnel and retirees. Social Security, Medicare, and Medicaid benefit payments would stop. So would student loan payments, tax refunds, and payments to keep government facilities open. This would be far worse than a government shutdown, which only affects non-essential discretionary programs.
The Government Simply Stopped Paying Interest
The second scenario would occur if the U.S. government simply decided that its debt was too high and it stopped paying interest on Treasury bills, notes, and bonds. In that case, the value of Treasurys on the secondary market would plummet.
Anyone trying to sell a Treasury would have to deeply discount it. The federal government could no longer sell Treasurys in its auctions, so the government would no longer be able to borrow to pay its bills.
Even the Threat of a Debt Default Is Bad
Even if investors only think the United States could default, the consequences could be almost as bad as an actual default.
U.S. debt is seen worldwide as the safest investment anywhere.
Most investors look at Treasurys as if they were 100% guaranteed by the U.S. government. Any threat of default could cause debt rating agencies, such as Moody’s and Standard and Poor’s, to lower the U.S. credit rating.
Here’s an idea of just how bad a lower credit rating could be. In April 2011, S&P only lowered its outlook on the U.S. debt from “stable” to “negative.” As a result, the Dow immediately dropped 140 points.3
Impact on the Economy
A U.S. debt default would significantly raise the cost of doing business. It would increase the cost of borrowing for firms. They would have to pay higher interest rates on loans and bonds to compete with the higher interest rates of U.S. Treasurys.
All U.S. interest rates would rise, increasing prices and contributing to inflation.
The stock market would also suffer, as any U.S. investment would be riskier. Stock prices would fall as investors fled to other countries’ safer stocks or gold. For these reasons, it could lead to another recession.
Read the rest: https://www.thebalance.com/u-s-debt-default-3306295