President Donald Trump speaks to members of the press from the White House on October 15, 2020, in Washington, DC. | Alex Wong/Getty Images
Failing to raise the debt ceiling would have potentially disastrous economic consequences.
The US will be in uncharted territory if lawmakers fail to reach an agreement on raising the debt ceiling. But the impact of the US defaulting on its debt would probably not be ‘“maybe nothing” or just “a bad week or a bad day,” as former President Donald Trump suggested in a CNN town hall Wednesday night, his first major media appearance since announcing his 2024 campaign.
Days after President Joe Biden had his first, fruitless meeting with congressional leaders on raising the debt ceiling, Treasury Secretary Janet Yellen warned Thursday that a default would not only “threaten the gains that we’ve worked so hard to make over the past few years in our pandemic recovery,” but would “spark a global downturn that would set us back much further.”
“It would also risk undermining US global economic leadership and raise questions about our ability to defend our national security interests,” she said.
There are a lot of unknowns about what a default would actually look like given that the US has never before run out of cash to pay all of the government’s bills on time. But experts say it definitely could get as bad as Yellen has projected, possibly causing stocks to plummet, sending the US into a recession, and damaging the economy in other unforeseen ways.
“The financial system is always a lot more fragile than you think,” said Louise Sheiner, a senior fellow in economic studies and policy director for the Hutchins Center on Fiscal and Monetary Policy at the Brookings Institution. “And so that’s why you don’t want to risk something like this.”
What is the likelihood that the US defaults on its debt, and what does that mean?
The US is already in the danger zone, having hit the $31.4 trillion debt ceiling set by Congress back in January. Since then, the country’s been taking what’s called “extraordinary measures” in fiscal accounting to keep things running. It’s hard to know exactly when the US will officially default, but without any agreement on raising the debt ceiling, experts have projected that it could happen as early as June 1.
Bernard Yaros Jr., an economist for Moody’s Analytics, said that he puts the probability of that happening at about 10 percent, but that’s still “a bit too high for comfort.” He said that, if the US crosses that threshold, it would likely only be for a few days, and the economic reaction could be reminiscent of the fallout from the failure of a $700 million bank bailout bill during the 2008 financial crisis. In the wake of that incident, stock markets cratered and public outrage put pressure on politicians to get their act together.
But if the crisis lasts longer than that, impacts on the US financial system could be even more far-reaching. In an analysis for Moody’s, Yaros looks at a possible worst-case scenario where the US remains in default through July. He and his colleagues estimate that would lead to the unemployment rate rising to 8 percent and a peak GDP decline of about 4 percent, comparable to the levels during and after the 2008 financial crisis.
“When it comes down to a debt limit, every single bit of federal spending comes under question,” Yaros said. “That, along with loss of consumer confidence and business confidence, then further reduce consumer spending through negative wealth effects. All of that is more than enough to tip the US into a recession.”
Interest rates could increase further, making it even harder to buy a house or start a business, and the 66 million Americans who receive Social Security benefits could see their checks delayed. Health care providers who have patients on Medicaid and Medicare might also see delays in payment. The roughly 2.1 million federal civilian employees wouldn’t get paid, meaning that they wouldn’t be able to spend as much as they otherwise would, feeding into a possible recession.
Yellen has also warned that the US could see its AAA credit rating downgraded, as it did in 2011 by S&P Global Ratings. Yaros thinks that, for now, the likelihood of that happening across credit ratings agencies is low. Moody’s Investors Service has indicated it won’t do so long as the Treasury continues to make bond payments. But if it does happen, it would lead to a crisis of confidence that could have a “cascade of credit implications and probably downgrades on the debt of other financial institutions” that are backstopped by the US government, such as Fannie Mae, Freddie Mac, and the Federal Home Loan Banks, he said.
“Any kind of lost confidence in the US [dollar] as the safest and most liquid asset in the world — which we’ve already had — is not good. But how bad and how long-lasting? It’s hard to say,” Sheiner said.