Explainer-Standing at the precipice, Washington courts debt limit catastrophe By Reuters
By Jason Lange, Megan Davies and David Randall
WASHINGTON (Reuters) – A standoff in Washington between President Joe Biden’s Democrats and Republicans is threatening to trigger a financial and economic meltdown if Congress fails to act by about Oct. 18, when the Treasury Department expects to run out of cash to cover its expenses.
In the United States, brinksmanship have been a constant feature over the past decade. The familiar battle belies the grave dangers that the largest economy in the world would face if its debts default.
WHY WOULD CROSSING THE DEBT CEILING BE CATASTROPHIC
Washington can only receive incoming taxes to pay its bills if it exceeds its borrowing limit of $28.4 billion. The Treasury, which currently borrows 20 cents per dollar, would begin missing money owed to citizens, money lenders or both.
As investors begin to question the U.S. bond’s value as a key component of the financial system, shockwaves will ripple across global markets.
As the U.S. government failed to pay on payments on all aspects of its financial system, including Social Security payments for the elderly and soldiers’ wages, domestic spending reductions would cause the economy to fall into recession. Economists predict that millions of Americans will lose their jobs if there is a financial crisis.
WASHINGTON HAS MANY OPTIONS.
Experts agree that the easiest thing to do is eliminate the borrowing limit.
Since its inception in 1917, the debt limit has been a focal point of political debates throughout the 20th century. In 2011 it became an actual crisis when politics almost caused a default.
Some experts believe the U.S. Constitution violates the debt limit. However, the Biden administration could be sued if it invoked this argument.
The U.S. Treasury’s 2011 emergency plans provide a guideline scenario. In the midst of the political crisis that hit in 2011, the plan prioritized the payment to creditors on financial markets to prevent a debt default and cut back significantly on government spending obligations. This included payments to the sick and elderly.
IS IT AVAILABLE TO INVESTORS?
It could be that they are just getting started. Market reaction to the impasse in Washington has been muted despite recent warnings by Federal Reserve officials and Treasury officials. The stock index slid more than 2% on Tuesday, in part because of debt ceiling worries, but rebounded slightly on Wednesday. Investors believe that Biden’s Democrats can resolve the crisis.
The market for Treasury bills shows signs of concern. Tallbacken Capital Advisors’ CEO Michael Purves stated in a Monday research note that Treasury bills due in one-month are now being offered at higher yields than bills due three months later. The reason for this is because these bills “presumably won’t be affected by default risk.”
Some investors fear that payments could be delayed by the government for some time.
WHAT DID IT DO IN 2011 AND HOW DANGEROUS?
During the 2011 debt ceiling crisis – between then-President Barack Obama’s Democrats and the right-wing Tea Party faction of Republicans – the S&P 500 plunged almost 20%. It later recovered but investors were rattled and the Standard & Poor’s credit rating agency put U.S. politicians on watch, downgrading America’s credit rating for the first time in history.