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Gold price settles above $2,020 as Yellen warns of 'constitutional crisis' if debt cap not raised

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(Kitco News) With the chance of a U.S. default in a matter of weeks, U.S. Treasury Secretary Janet Yellen warned that if the debt ceiling is not lifted, it could trigger a "constitutional crisis."

"It's Congress's job to do this. If they fail to do it, we will have an economic and financial catastrophe that will be of our own making," Yellen told ABC on Sunday. "And we should not get to the point where we need to consider whether the president can go on issuing debt. This would be a constitutional crisis."

The debt cap negotiations should not be done "with a gun to the head of the American people," Yellen added.

The latest message comes ahead of U.S. President Joe Biden's Tuesday meeting with Republican House Speaker Kevin McCarthy, Republican Senate Minority Leader Mitch McConnell and top congressional Democrats to discuss the debt issue.

"The meeting between President Biden and Republican leaders on Tuesday to discuss the U.S. debt ceiling will be closely watched. We think that political talks will go on for some time before an agreement to raise the debt ceiling is finally reached, which could weigh on risk appetite," Capital Economics commodity economists said.

Negotiations are currently at an impasse after the Republican-led House of Representatives passed a bill in April that would raise the debt ceiling conditional on extensive spending cuts, which Biden is against.

The federal government reached the cap on borrowing back in January. Since then, the Treasury has employed "extraordinary measures" to pay the bills.

Last week, Yellen told Congress that the U.S. could run out of money by June 1. "After reviewing recent federal tax receipts, our best estimate is that we will be unable to continue to satisfy all of the government's obligations by early June, and potentially as early as June 1, if Congress does not raise or suspend the debt limit before that time," Yellen wrote in a letter to House Speaker Kevin McCarthy.

Uncertainty over the debt ceiling has been one of gold's drivers during the past month. "Gold and silver prices rose, which can only be explained by safe-haven demand in a week when another U.S. bank failed and concerns mounted about the approach of the U.S. debt ceiling," economists at Capital Economics said. "We suspect that the gold price will remain elevated while concerns about the banking sector and debt ceiling persist."

On Monday, gold hit a daily high of $2,037.10 an ounce, with June Comex gold futures last trading at $2,028.00, up 0.16% on the day.

"Gold looks like it wants to make another run towards record territory. Too many recessionary risks are on the table for gold to see a significant pullback," OANDA senior market analyst Edward Moya said.

Analysts expect negotiations over the debt ceiling to get right down to the wire but ultimately avoid a default. In the meantime, volatility remains the name of the game, said ABN AMRO senior U.S. economist Bill Diviney.

"Financial markets are likely to become increasingly sensitive to developments over the coming weeks as the U.S. Treasury runs down its cash buffers," Diviney said Monday. "Similar to the 2011 debt ceiling impasse, the government is divided along partisan lines, with Democrats controlling the presidency and the Senate, and Republicans controlling the House."

To learn more about how gold behaved during the 2011 debt ceiling crisis, click here.

A default scenario, something that most analysts are ruling out, will have profound negative implications for the U.S. economy.

"A technical default – one that involves the government missing coupon payments and therefore triggering credit default swaps – is highly unlikely. Should the Treasury run out of cash, we expect it to prioritise bond coupon payments over other financial commitments, even if that means swingeing cuts to spending and a partial government shutdown," Diviney said. "However, the longer this were to go on for, the negative impact on financial markets and on the economy would become increasingly non-linear."

One major negative effect would be bond yields falling, with demand for safe havens offsetting higher risk premium effects, Diviney added. "This happened during the 2011 debt ceiling impasse when S&P downgraded the U.S. sovereign from AAA to AA+," he said.

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