Breaching the Debt Ceiling Will Cause A Mess, One Way or Another
No one knows what breaching the debt ceiling will look like, but it won't be good
October 15, 2013
What happens if the U.S. defaults? I wrote an issue brief about that last week. But, of course, I don't know. I've sketched out the likely best-case scenario, but the worst-case scenario is hard to contemplate.
The best-case scenario looks pretty bad. The Treasury Department put out a report this week pointing out a few of the major consequences of almost defaulting back in 2011. That incident led to a 17 percent decline in stock market value, which wiped out $2.4 trillion in household wealth, as well as big increases in home mortgage and business borrowing costs and an increase in the interest premium paid on the national debt.
If those are all effects of getting close to defaulting, what happens if we do default? It's a question that's hard to answer.
Countries default all the time (OK, not all the time, but it happens). There's excellent research on what happens before, during and after a default. It's catastrophic, but in a predictable way. Investors get spooked, pull capital out of the defaulting country, take losses and move their money to safer assets – usually U.S. Treasuries (you know, the ones we're talking about defaulting on now).
This is terrible, and it would be a great comparison if U.S. government debt were typical. But it isn't. Treasury debt is the linchpin of the domestic and international financial system exactly because the U.S. government has a 200-year history of never behaving this irresponsibly.
Today's fast-paced, highly electronic markets rely – to a surprising degree – on simple trust. Once any uncertainty is introduced into the system, the millions of transactions that happen seamlessly every day suddenly require considerably more due diligence than the system is built to handle and make them less liquid. A U.S. default represents a crazy risk to the international financial system. So there's that.
There's also the grinding austerity a failure to lift the debt ceiling would automatically impose on the U.S. economy. The best case scenario here relies on dubious claims that treasury could costlessly reprioritize payments and balance the budget day to day. Goldman Sachs estimates that rosy scenario would cut GDP, currently growing at about 2.5 percent, by 1.7 percent over the first month.
I don't know what will happen if the U.S. defaults on its debt. I'm OK with that. You should be too. Sometimes looking over the edge of a cliff tells you all you need to know about what happens when you jump off.
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