Next month, Americans will once again serve as an unwilling audience to a dramatic standoff over the debt ceiling. While I often tell my clients that matters are less dire than media coverage suggests, in this case, a potential default really is a potential disaster.
The United States came within weeks of a potential catastrophic default in September, forcing the Treasury to deploy emergency measures to prevent funds from running out. Senior Democratic leaders have insisted that lawmakers find a bipartisan solution. Senate Republicans have been equally adamant that Democrats alone should be responsible for, as they frame it, increasing the nation’s debt.
The tense September negotiations left investors worried. The S&P 500 fell 4.8%, the index’s worst monthly performance since March 2020. Analysts cited a variety of reasons for the stock market drop, but the debt ceiling debate was prominent among them. Investors understandably find it hard to remain optimistic when their government is within days of defaulting on its debt.
The stock market bounced back promptly once legislators struck a short-term deal to raise the debt ceiling, with the S&P 500 climbing 6.9% in October. However, we could soon face a replay. Congress needs to make a decision as soon as Dec. 3, unless lawmakers take measures to kick the can farther down the road.
The real risk of not raising the debt ceiling is a default on the government’s outstanding borrowings, a failure to timely meet its financial obligations and commitments, or both. The debt ceiling is the amount of debt that the Treasury is allowed to issue to pay the country’s bills. While lawmakers often discuss new spending during fights over the debt ceiling, lifting the debt limit does not authorize any new spending. But refusing to lift it does carry dire ramifications.
There is not much of a window between a potential missed deadline and disaster. Treasury Secretary Janet Yellen has estimated that the federal government could run short of cash within a few weeks if Congress refused to increase its borrowing authority. The government only takes in roughly 70 cents for every dollar of spending, so the Treasury would quickly run through any cash cushion.
Some observers may wonder whether a default would really be that bad. Argentina has defaulted nine times, twice since 2000, and has continued to borrow additional funds from receptive lenders. While no one would point to the Latin American nation as a fiscal role model, its struggles have not been world-ending. When Russia defaulted in 1998, it signaled the beginning of a painful transition toward a market economy, not Armageddon. Would default by the United States be truly catastrophic?
Maybe. A U.S default would be very bad, on a scale far beyond previous national defaults.
Unlike other countries that have defaulted in the past, the United States plays a prominent and unique role in the global economy. Its default would be an unprecedented event, and would have serious ramifications both at home and abroad. While no one can say for certain how a default would play out, economists agree that a U.S. default would upend international markets and would risk sending the country into a recession.
An immediate question would be how Treasury officials would prioritize the country’s obligations. It would have to balance the claims of Social Security beneficiaries, current and former members of the armed forces, bondholders who hold U.S. debt, and a variety of other parties who expect the government to pay what it promised in full and on time.
It is most likely that Treasury debt holders would be first in line. By rolling over maturing debt principal and prioritizing interest payments, the government could use its incoming cash to avoid a technical default on the national debt. In that case, Americans who count on social support programs would likely be the ones to face late or skipped payments. In many instances, these recipients do not have the cushion necessary to easily weather that outcome and would quickly run into financial difficulties.
Treasury holders are likely to be prioritized because if they weren’t paid for an extended period, the worldwide chaos would be hard to imagine. U.S. Treasury securities are incredibly popular globally because everyone views them as safe investments. Banks frequently use U.S. Treasury debt for collateral, especially on short-term loans. Internationally, U.S. Treasuries are often treated as equivalent to cash because they are so secure. Even the idea, let alone the reality, of the United States defaulting could create a global panic.
It is also possible that no one could get paid at all in the short term. A Treasury inspector general report from 2012 revealed that during the 2011 debt ceiling debate, the Treasury determined it would wait until it could pay a full day’s bills before cutting any checks. That approach, however, was reportedly never presented to then-President Barack Obama for his approval. In such a scenario, the disaster would be immediate, rather than rolling from one group to another.
It is in everyone’s best interests for the U.S. to avoid default. This raises the question of why lawmakers continue to bring the country so close to the edge. The short answer is brinkmanship.
Lawmakers from both parties agree that it is important to raise the debt ceiling to avoid the economic disaster of default. Yet in a cycle that has played out on repeat, Republicans insist that Democrats raise the debt ceiling alone, through the budget reconciliation process. Republicans can then tell their constituents that they did not help Democrats to increase spending. In turn, Democrats drag their feet on using reconciliation to move forward, pointing out that raising the debt ceiling services debt the government already took on during previous administrations, including Republican ones.
If Republicans hold firm, Democrats likely will use the budget reconciliation process to bypass the need for a 60-vote majority in the Senate to avoid a default. Some experts have also suggested that the 14th Amendment authorizes the president to act unilaterally, though others have warned that this approach could trigger a constitutional crisis. It is unlikely that President Joe Biden will take this route if other options remain.
Yellen told The Washington Post that not raising the debt ceiling would be “the worst possible outcome.” She said, “Should it be done on a bipartisan basis? Absolutely,” but added, “If Democrats have to do it by themselves, that’s better than defaulting on the debt to teach the Republicans a lesson.” While Yellen can only use the levers available to her, the economic truth is that political posturing puts the U.S. economy, and many individual Americans, in financial danger.
We should make it explicit, not implicit, that the government cannot default. Even if such a default was essentially an accident caused by political miscalculation, the consequences are too dire to risk. Most other countries do not have a debt ceiling at all. Instead they constrain debt to a certain percent of the country’s gross domestic product, or an incoming government sets a target for a prudent amount of debt over the course of its administration.
One approach that U.S. policymakers have discussed is changing the debt limit to automatically reset to reflect the spending Congress has previously authorized. Lawmakers could also fully abolish the debt ceiling outright. Yellen has signaled her support for this approach, though Biden has not.
Playing chicken with the debt ceiling is a symptom of our current hyperpartisan climate. Cooler heads should ensure we don’t find ourselves in a financial disaster entirely of our own making.