The Consequences of a Potential US Government Default on its Debt
The potential for the United States government to default on its debt has far-reaching consequences, both domestically and internationally. A default would seriously impact the global economy, which relies on the relative stability of the United States. Interest rates would increase and investment into Treasury securities would stop, impacting people's car loans, credit cards, and more. As we navigate the political and economic complexities of raising the debt ceiling in the coming weeks, it’s important to understand what could happen if the U.S. defaults on its debt. The consequences of such an event would have a major impact not only in the U.S., but across the globe. And while we can’t predict the exact outcomes, based on economic studies, expert opinions, and historical precedent, there are some possible scenarios that could unfold.
In the event of a default by the United States, the potential economic ramifications could be disastrous, including furloughs for countless federal employees, suspension of Social Security and Medicare payments, plummeting of the stock market, and a widespread recession. The debt ceiling, which used to be a standard legislative process, has transformed into a battlefield for partisan disagreements and ideological conflicts. Gone are the days when raising the debt ceiling was viewed as a “routine” step to ensure the continued functioning of the government and the fulfillment of its financial obligations. Instead, it has evolved into a highly debated issue, serving as a symbol of the wider political rift that exists throughout Capitol Hill.
Previous debt ceiling negotiations were also stalled under the Obama administration, marking a new standard of polarized political battles when it came to discussing the government’s spending budget. In 2011, House Republicans fought for months to decrease the deficit in exchange for a debt ceiling raise, impacting the country’s credit ranking for the first time ever. Conversations came to a close two days prior to the announcement by the Treasury that the United States would have depleted all its funds. The United States Government Accountability Office reports that the postponement of the vote to increase the debt ceiling had a negative impact on the stock market and caused the country to incur an extra $1.3 billion in borrowing costs in 2011.
Treasury Secretary Janet Yellen recently warned that unless Congress raises (or suspends) the debt limit, the U.S. government may run out of money as early as June 1. The U.S. government hit its congressionally imposed $31.4 trillion borrowing limit in January, and unless Congress raises or suspends the debt limit, the federal government will lack the cash to pay all its obligations. Yellen has stressed the urgent need for Congress to address the debt ceiling, describing how a failure to raise or suspend the debt limit would be “catastrophic” for the financial system, families and businesses.
The two sides are still far from agreeing on how to address the debt ceiling. House Republicans, led by Speaker Kevin McCarthy, have proposed raising the debt ceiling in exchange for deep spending cuts, while Democrats argue that raising the debt ceiling should not be tied to program and policy decisions. The Treasury Department has said the federal government could likely default by June 1 unless Congress acts to lift the debt ceiling.
A nonpartisan congressional report cited a “significant risk” of a historic default within the first two weeks of June. A report by the U.S. Congressional Budget Office confirmed statements by Treasury Secretary Janet Yellen’s warning that a government default could come as early as June 1. The consequences of a potential default on the U.S.'s debt obligations would be far-reaching, resulting in a variety of unfavorable outcomes. One of the possible outcomes is a decrease in the credit rating of Treasury bonds, which could lead to reduced faith and reliance on U.S. government securities. Consequently, this would result in increased interest rates for borrowing among US individuals, businesses, and the government. Moreover, investors worldwide might choose to dispose of their assets denominated in dollars, leading to a decline in the dollar's value in the international currency markets.
Zillow, a website specializing in real estate, predicts that in the event of the United States defaulting on its debts, mortgage rates may increase by up to two percent by September, with a subsequent decline. With that, we’d see a massive contraction of the housing market. A default would likely trigger a downgrade of the U.S. credit rating, which could happen even with the threat of a default. It would be catastrophic for the economy, leading to an unprecedented economic and financial storm that could trigger an income shock and lead to recession.
The global financial system relies heavily on U.S. Treasury bonds and U.S. dollars. A default could lead to a loss of confidence in the U.S. government and a global market panic. The noticeable effect of this would manifest in the depreciation of asset values and disruption of global commerce. The length of the panic would depend on the extent of the U.S. default and the speed at which the U.S. could rebuild trust in the financial markets. If a default were to occur, it would crack open the foundations upon which our financial system is built.
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