Debt default is a threat to household wealth
Among the most vexing decisions that investors and economic planners make is how to position for so-called tail risks, or low probability/high consequence events.
At a minimum — and probably more — the looming showdown over raising the U.S. debt ceiling qualifies as such. In fact, a default on the nation’s debt could cause a massive and long-lasting hit to household wealth, because the consequences would be catastrophic and irreversible.
To review: By late spring or early summer — the U.S. will hit its statutory borrowing limit, preventing the government from paying bills that Congress already had authorized. Those bills could include interest on existing bonds, principal on maturing ones, Social Security and Medicare payments, and salaries for government workers, including service members.
Raising the debt ceiling does not authorize new spending, but Republican members of Congress have threatened to withhold approval without future budget cuts. Performance art?
We’ve been here before, most recently in 2011 when the U.S. came within days of defaulting on its debt. A study by the Government Accountability Office later determined that the delay cost the government $1.3 billion in added interest expense in that year alone, with higher costs down the road. Yet as perilous as that crisis was, this one feels worse.
Anti-government sentiment could have serious consequences
While some of the current brinksmanship may be performance art intended to fire up the base, there is an unmistakable anti-government, burnit-down attitude among some House members that could make compromise impossible. As The Economist newspaper recently wrote, “it is not clear what House Republicans would want in return: the chaos may be the point.”
Raising the debt limit requires the House speaker to put the issue to a vote before the full chamber. Yet because of deals that speaker Kevin McCarthy made with far-right members of his party to gain the leadership, if even one person objects, that member could trigger a vote to “vacate the chair,” from which it would take only five votes to remove him.
Voilà! No speaker, no vote — and a first-ever U.S. government default.
Undoing Biden agenda called ‘beautiful and joyous’
No one should question that demographic change has made government debt a serious problem. The last
balanced Federal budget was in the final year of the Clinton administration. But voters share responsibility for the deficits, along with the politicians they elected.
The three tax cuts enacted by two Republican presidents since 2001 failed to pay for themselves, yet were supported by their constituents, just as the unfunded spending increases enacted by Democratic administrations were supported by their voters. Republicans allowed three “clean” debt ceiling increases during the Trump administration2 as the national debt soared by $7.8 trillion through unneeded tax cuts and urgently-needed pandemic stimulus.
In 2017, President Donald Trump — the self-proclaimed “King of debt”— thought there were “a lot of good reasons” to get rid of the debt ceiling. “It complicates things,” he said, “it’s really not necessary.” But in a recent social media post, the now-former president claimed that by threatening default, Republicans could undo “almost everything” that President Joe Biden accomplished, a reversal that he termed “a beautiful and joyous thing.”
A default would trigger financial Armageddon
Actually, economic suicide is not painless, beautiful or joyous.
A recent simulation by Moody’s Analytics found that “the economic downturn ensuing from a political impasse lasting even a few weeks would be comparable to that suffered during the global financial crisis. That means real GDP would decline almost 4% peak to trough, nearly 6 million jobs would be lost, and the unemployment rate would surge to over 7%.” Stock prices were projected to drop by almost one-third and household wealth by $12 trillion.
There would be few places for investors to hide. When a foundation collapses, it matters little what room you are in. The dollar would plunge, Treasury yields would gyrate wildly and money market funds might “break the buck.” Borrowing costs would permanently rise for governments, businesses and households.
Avoiding economic and financial calamity may hinge on voter attitudes in the 20 districts that are home to the far-right Freedom Caucus members that seem particularly motivated to block a debt ceiling vote without budgetary concessions. Do their constituents understand the consequences of a default for the country, and their own finances? Do they know that raising the debt limit only pays for previously authorized bills? Are they willing to make cuts to Social Security and Medicare for future generations that they were not willing to make for themselves?
Unlikely as default might be, the U.S. Treasury would have no good options for dealing with the crisis. The deficit scolds know that. How sad if chaos really is the point.