Nobody knows exactly what will happen to the economy if the United States breaches the debt ceiling, though every possible option ranges from mildly bad to total and complete disaster to the tune of trillions of dollars. As the clock ticks on negotiations, it’s getting increasingly likely that we may get to see the consequences live and in color.
The debt ceiling is a federally imposed limit on how much debt the federal government can rack up, how much money it can borrow to pay its bills. It has been in place since 1917. Every time the government gets close to that ceiling, Congress needs to raise it and say it’s okay to keep taking on debt. It’s done so nearly 80 times since 1960.
Sometimes, these debt ceiling increases come with a bit of drama. In 2011, the US came within 72 hours of defaulting on its debt, and now, once again, the country is on the brink of screwing this all up unless Republicans and Democrats in Washington come to an agreement on what to do. Democrats and the White House would like to lift the ceiling without any strings attached; the GOP really wants strings. (Vox has a full explainer on the debt ceiling here.)
So, the US is ambling — or hurtling — toward the so-called “X-date,” when the Treasury Department really finds itself in a bind and can no longer meet its obligations. The X-date is now set for June 5, and what exactly the X-date entails is not clear. But it’s not good for the country or the economy.
“It really depends on how long the breach is and what agreement is reached to end the breach,” said Mark Zandi, chief economist at Moody’s Analytics. “The longer-term consequences of a breach are significant ... so not breaching is really quite important.”
In other words, it would definitely be best if Congress and the White House did not, as the meme goes, fuck around and find out. But they might.
The US breaching the debt ceiling is a sliding scale of bad
There’s no world where the Treasury Department runs out of money on June 5 or whatever and then everybody’s like, “Actually, you know what, that wasn’t a big deal after all.” The economy is quite unpredictable, but what we can predict is that the fallout would be negative.
“It depends a little on what the Treasury decides to do,” said Eric Swanson, an economist at the University of California Irvine. “They would have to basically delay paying bills, and the question is which bills they delay paying, and the effects would depend a little bit on that.”
Treasury would likely continue to make principal and interest payments on its debt, experts say, because not doing so would result in the worst of many negative possible outcomes. In 2011, Treasury and the Federal Reserve planned to prioritize interest payments if push came to shove.
“If Treasury doesn’t do that, that would be cataclysmic out of the gate,” Zandi said. “There would be widespread downgrades, and I think interest rates would go skyward, stock prices would go south, the economy would evaporate.”
What that means, in turn, is that Treasury would have to look elsewhere and start paying other obligations late. That would likely entail hitting pause on Medicare reimbursements to doctors and hospitals, delaying Social Security checks and veterans’ benefits, and missing paychecks to government workers.
“If they stop making payments to various recipients of government spending, the question is do they have a rule for how they do it, and who do they not make payments to?” said George Hall, an economist at Brandeis University.
Such maneuvers would, of course, hurt those directly affected — many seniors, for example, rely on Social Security to make it through the day-to-day. They would also have ripple effects — Bob doesn’t get his check, so he can’t pay his rent, so his landlord can’t pay his mortgage, and so on.
“There are always these linkages of payments,” Hall said.
Don’t freak out. (Everybody is going to freak out.)
There will likely be some legal wrangling around whether Treasury is allowed to pick and choose which financial obligations it meets instead of just paying bills as they come due. In January, Treasury Secretary Janet Yellen said the department’s systems aren’t built to prioritize certain payments over others. Pretty much as soon as things start to go a little awry with Medicare or Social Security, there’s likely to be lots of panic anyway.
“The effects of those delays are obviously negative and potentially really bad for somebody who is dependent on that check coming on a particular day, but I think the direct economic effect of those delays on individuals will be dwarfed by the overall economic response,” said Wendy Edelberg, the director of the Hamilton Project and a senior fellow in economic studies at the Brookings Institution. What happens to the stock market? Confidence among businesses and households? It’s going to be a time to postpone investments and business decisions. “I suspect Treasury markets will respond even though their payments are going to be on time.”
Thus far, the stock market appears to feel fairly confident that Democrats and Republicans are going to reach a deal on the debt ceiling and that all hell is not about to break loose, said Sam Stovall, chief investment strategist at CFRA Research. “We on Wall Street realize that Washington can teach Hollywood a thing or two about drama,” he said. “Knowing what the repercussions would be to the economy, to our standing in global trade, to the US currency being the reserve currency of the world, there’s just too much at stake.”
That’s the hope. However, as time runs out and the situation becomes more precarious, sentiment on Wall Street may change. “If we end up with us going too long, like June, maybe we don’t officially default but we get closer and closer, I think we start to take on the characteristics of 2011,” Stovall said. The 2011 turmoil sent the S&P 500 into deep correction territory, he said, with only three sub-industries in positive territory from late April to early December: gold, electric utilities, and restaurants.
Market sentiment being relatively okay for now doesn’t mean it will stay that way forever. “It’s one of those things where it’s okay, it’s okay, it’s very much not okay,” Zandi said. It may not take much to shake confidence, especially once cracks start to show and the government starts to delay some payments. “The uncertainty may be worse than the payment failures themselves,” Hall said.
The immediate worst-case scenario is that the US defaults on its debts and doesn’t make interest payments. Again, that’s super unlikely, but if it were to happen, it would be bad bad bad bad bad.
“The scary scenario is that there’s lots of contracts that are written on top of Treasury debt, that use Treasury debt to determine payouts and prices and things like that, and if this causes all of those markets to lock up,” Hall said, “then really bad things are going to happen. People aren’t going to get credit and serious things.”
When push comes to shove, many experts say it’s hard to imagine Treasury wouldn’t pay bondholders. It and the Federal Reserve will try to find a way not to toss everything into complete chaos.
“I’m kind of confident, if it’s a short-lived crisis, the Fed will figure out a way, there are pretty smart people there, they’ll figure out a way to minimize the damage in the plumbing,” Hall said. “I haven’t sold all my Treasuries, I’ll put it that way.”
The longer this goes on, the worse it gets
Already, all the will-they-or-won’t-they wrangling over the debt ceiling is not great for the economy or anyone involved. As the New York Times notes, the uncertainty might increase borrowing costs, destabilize financial markets, and make an already shaky economy even shakier. In the long term, the standoff could damage confidence in the US financial system and government. It’s not great for the US to look like clowns on the international stage.
“This is all about faith, it’s all about the belief that we’ve worked hard at since the beginning of our nation, and blowing away that faith, that confidence, I don’t think people really understand how valuable that is,” Zandi said.
The 2011 brinksmanship over the debt led to a $2.4 trillion decline in household wealth, and the debt limit wasn’t even breached.
If X-date arrives and there really is no deal and the federal government does start to miss payments, the longer that situation goes on, the worse the landscape becomes. A couple of days isn’t ideal, at the very least because it’s going to cause panic, but if it’s weeks, well, buckle up.
“It’s a little bit of a question of how long this goes,” Hall said. “If it’s three days and it’s somehow papered over, no big deal.”
If it goes on for a week, three, four, “words like ‘catastrophic’ come to mind,” Zandi said. “At that point, the cuts in government spending would be so significant, confidence would be so undermined, the markets in such turmoil that I think we’d experience a very severe financial crisis-like downturn.”
“Imagine a world where Treasury announces that they have to juggle a payment, something gets delayed, we see a reaction in financial markets, I don’t know what that is, I don’t know what happens, but I know it’s going to be topsy-turvy,” Edelberg said. “We have breathless news coverage, everyone’s freaked out, emergency meetings among policymakers, imagine all of that happening, and 24 hours later, still no deal.”
It would be better to just not have to find out what happens if we breach the debt ceiling
Because the situation would be so unprecedented if the US breaches the debt ceiling, really, nobody knows what would happen. Predictions vary. Everybody’s guessing.
Some of the prognostications out there are truly terrifying. Goldman Sachs analysts have estimated that not paying Social Security checks, federal workers, and bondholders would halt one-tenth of US economic activity. Analysts at Zillow have suggested that a debt ceiling default would drive mortgage rates above 8 percent and a 23 percent decline in housing market activity.
The White House has warned that a protracted default scenario would lead to the loss of 8 million jobs and an “immediate, sharp recession” on the order of magnitude of the Great Recession. Many analysts and observers say that a breach would tank the stock market, send bond yields soaring, increase interest rates, and cause the US’s credit to be downgraded.
“A number of different scenarios are possible, with the implications for the US economy ranging from bad to dire,” wrote Megan Greene, chief global economist at Kroll, in a recent analysis. “Depending on how long the situation lasts, how it is managed and how investors react, there is enormous uncertainty about the damage that might be wrought if the debt ceiling binds.”
So it looks like we shouldn’t do this. Sure, breaching the debt ceiling for a couple of days until the people on Capitol Hill reach a deal could perhaps wind up being not completely calamitous, but is that really a risk worth taking? What if the standoff goes on for a long time, or even a day or two of insecurity really winds up being a disaster? And even if a breach is short-lived, what sort of damage does it do, long term, to the US and its reputation? If the government screws this up once, what’s to stop them from doing it again?
The answer to what happens to the economy if the US doesn’t come to an agreement on the debt ceiling is one we would all be better off not knowing. Hopefully, Washington negotiators realize that, too.
“They’re playing a game of chicken,” Zandi said, “and you just don’t know who’s going to turn the car first.”
Update, May 26, 4:30 pm ET: This story has been updated with the X-date, June 5.