Republicans in Congress and President Joe Biden have resumed urgent negotiations to prevent a damaging US debt default, which Treasury officials recently warned could happen as soon as June 1.
Insisting that a default would have “catastrophic” repercussions, Biden is pleading with Republicans to consent to a “clean” increase in the debt ceiling before the deadline arrives.
Republicans have retaliated, saying that in exchange for their support in extending the nation’s borrowing authority, Democrats must promise to cut spending in the future.
Here is what could happen in the United States, and around the world, if the US fails to raise the debt ceiling:
What would it mean for financial markets?
Analysts predict that if the Treasury is unable to pay all of its debts, the US stock markets will likely experience a sudden, severe shock.
Interest rates would rise along with a drop in US stocks, particularly Treasury yields and mortgage rates, according to Moody’s Analytics economist Bernard Yaros, speaking to AFP.
According to him, this would result in higher borrowing costs for both consumers and businesses.
According to Yaros, households or businesses that are owed federal payments will probably reduce their spending in the near future as a result of their loss of income. Additionally, consumer confidence may deteriorate, which would be detrimental to the economy.
But any shocks are expected to be short-lived, with politicians likely to respond forcefully to any meaningful market reaction.
“I also would expect that once the deal’s done the markets bounce back,” Citigroup Global Chief Economist Nathan Sheets told AFP.
“I don’t think that this episode is likely to be sufficiently long-lived that we should be calculating lower GDP forecasts,” he said.
What does the US Debt default mean for government?
The United States will still have options even if it misses the X-date, which is the time when the government runs out of money to cover all of its debts.
It might, for example, decide to defer making other payments to beneficiaries of Social Security, federal agencies, or Medicare providers in favor of paying off debt.
According to Wendy Edelberg, senior fellow in economic studies at the Brookings Institution, this is the scenario that is most likely to occur.
Treasury officials prepared backup plans during a similar debt ceiling standoff in 2011 to avoid a default on Treasury securities and to guarantee that the Treasury would continue to pay interest on those securities as it became due.
A government shutdown would be unlikely, although federal workers’ paychecks could be delayed, Edelberg said.
What would it mean for global economy?
Even if the US misses the X-date but continues repaying investors, the consequences of the political failure to reach an agreement would likely ripple through global markets.
The government’s inability to pay all its bills “would raise serious doubts about the nation’s creditworthiness, sap the confidence of lenders, call into question the dollar’s place as a reserve currency, and increase federal borrowing costs,” Paul Van de Water from the nonpartisan Center on Budget and Policy Priorities wrote in a recent blog post.
“Under the present circumstances, even the serious threat of a US default could be enough to roil markets and further damage the global economy,” he said.
In the unlikely event of a default, the consequences would be substantial, according to Eric Dor, director of economic studies at IESEG business school in France.
“The interest rates charged by investors on bonds issued by the United States would rise sharply,” as would private debt, which uses US government debt as a benchmark, he said.
“This increase in the cost of credit would cause a drop in business and household investment, as well as in consumption, and thus a sharp recession in the United States,” Dor continued, adding it could also cause a recession in Europe and elsewhere.
“A default would destabilize the global financial system, which depends on the stability of the dollar as the world’s safe asset and primary reserve currency,” Jean Ross from the nonpartisan Center for American Progress wrote in a recent article.
“A loss of confidence in the dollar could have far-reaching economic and foreign policy ramifications, as other countries, particularly China, would use default to push for their currency to serve as the foundation of global trade,” she said.
Could US debt be downgraded?
Investors are anxiously observing the rating agencies as the X-date approaches in search of clues about a potential downgrade of US debt.
A similar debt ceiling impasse led rating agency S&P to downgrade the US credit rating from AAA to AA+ in 2011, which sparked outrage from both sides of the political aisle.
According to Nathan Sheets from Citi, the rating agencies will probably take notice even if the United States reaches the debt ceiling but continues to pay its bills, emphasizing the need for a negotiated agreement in advance.
“Debates about whether or not you pay to occur periodically is typically not a feature that you would associate with a top credit” rating, he said.
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