WASHINGTON, April 25 (Reuters Breakingviews) - Sometime between June and July, the United States will run out of cash. That will be President Joe Biden’s first major test since announcing his run for a second term in the White House today. If Democrats and Republicans can’t agree to lift the government’s borrowing limit, the country could suffer an unprecedented and catastrophic default on its debt. History suggests lawmakers will come to a last-minute deal, but even a close call could upend fragile markets. After bank failures and heightened volatility, the last thing that Biden – and the U.S. financial system – needs is an entirely avoidable crisis.
Investors tend to worry about “black swans,” or unpredictable, rare and catastrophic events, in the definition of author Nassim Nicholas Taleb. Washington is currently threatened by a different animal. The standoff over the debt ceiling is a white swan, or an entirely predictable, very frequent event that has the potential to be as catastrophic as its darker sibling.
Congress has sparred over the debt ceiling, which caps how much the Treasury Department can borrow to pay off its bills, nearly 80 times since 1960. The latest limit is $31.4 trillion, and lawmakers are quickly coming up to the next deadline. Moody’s Analytics reckons that the so-called “X-date” could arrive in late July. Weaker-than-expected tax revenue, however, ups the odds that the government will run out of cash as soon as early June, the firm added.
Reaching that deadline without a congressional fix would lead to a calamitous default. The Treasury would be prevented from issuing debt to fund the nation’s needs. That, in turn, would force the government to dramatically cut spending to erase its $350 billion budget deficit. Those cuts would, in just one year, shrink the economy by 4% and eliminate some 7 million jobs, lifting the unemployment rate to 8% from today’s 3.5%, according to Moody’s. The stock market would tank on the news, losing a fifth of its value and destroying $10 trillion in household wealth. Even if lawmakers quickly reinstate the government’s borrowing power, the economy would still be down 900,000 jobs a decade out from the default scare, the credit rating agency estimates. On top of that, the Federal Reserve probably won’t be able to accept U.S. government bonds as collateral, making it almost impossible for the central bank to provide liquidity to the financial system.
That is why, in all past scuffles over government borrowing, Congress ended up raising or suspending the debt ceiling. And while markets are betting on yet another fix, that confidence is starting to crack. The cost of insuring against a government default, as measured by credit-default swaps on Treasury bonds, has climbed to the highest level in more than a decade. The yield on three-month Treasury bills, meanwhile, hit a 22-year high on Thursday, a sign that investors are avoiding bonds that would be affected by even a brief default.
Recent history shows that dangers abound even if Congress manages to reach a deal before the “X-date.” The U.S. government nearly defaulted in 2011 as intense partisanship blocked a deal until two days before the Treasury’s deadline. Uncertainty over the timing of the agreement led to the most volatile week for financial markets since the 2008 financial crisis. The Chicago Board Options Exchange’s VIX Index (.VIX), a measure of market shakiness, tripled. Corporate borrowing costs surged as investors fled to safer assets. And for the first time in history, a credit rating agency – S&P Global – downgraded the U.S. government’s debt.
A similar, albeit less harmful, episode came two years later. Without those two debt standoffs, the U.S. economy would have been $180 billion bigger by 2015, according to Moody’s. The unemployment rate would’ve been 0.7% lower.
Repeating the mistakes of 2011 and 2013 would exacerbate the very risks that sparked last month’s bank failures. If investors lose confidence in Treasuries’ riskless reputation, they will demand greater returns, as shown by the spike in the yields of short-dated Treasury bills.
A climb in yields of longer-dated securities would lower their value, posing risks to financial stability. Banks hold a lot of long-term Treasuries and their balance sheets would be hit if U.S. government bonds started depreciating. That dynamic, known as interest-rate risk, played a central role in the collapse of Silicon Valley Bank last month.
The U.S. dollar also derives much of its value from its perceived stability. Growing fears of a debt crisis could lead markets around the globe to question the safety of the greenback. Currencies like the Swiss franc and the euro could strengthen against the dollar as investors and central banks park their cash elsewhere. The dollar probably wouldn’t lose its status as the most prominent reserve currency, according to Moody’s, but its diminished value in the long run and the risk of another debt scare could erode America’s reputation as the world’s financial hub.
Progress toward a debt-ceiling deal could soothe investors’ fears, but partisanship stands in the way. Republicans in the House of Representatives are poised to advance a package on Tuesday that lifts the limit for one year, and a vote on the House floor could come as soon as Wednesday. But spending cuts included in the bill mean that the Democrat-controlled Senate will almost certainly block it. Biden has urged legislators to pass an extension without such conditions, but Republicans have balked at the idea.
After years of unexpected shocks, Congress faces an obvious threat. Failure to lift the debt ceiling soon can spark a vicious cycle of market anxiety, rising borrowing costs and bank stress. The incredibly high stakes mean history will probably repeat itself, with lawmakers reaching a deal to raise the limit. That still might not be enough. A lengthy delay could be all it takes to spook markets, send new tremors throughout the financial system and spoil Biden’s re-election effort just as it ramps up.
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CONTEXT NEWS
The U.S. government will lose its ability to pay its bills sometime between July and September unless the limit on federal borrowing is raised or suspended, the Congressional Budget Office said on Feb. 15.
Republican House Speaker Kevin McCarthy proposed a one-year increase to the debt ceiling on April 17 that includes spending cuts and policy tweaks, such as clawbacks of unspent pandemic relief funds. The House Rules Committee is expected to take the first procedural step toward advancing the bill on April 25, and a House floor vote on the measure could happen as early as April 26. Still, Democrats’ control of the Senate signals the Republican proposal won’t advance.
President Joe Biden announced on April 25 that he will seek a second presidential term in 2024. The debt-ceiling standoff, then, will mark one of the first major tests for Biden as he begins his re-election campaign.
