What if the U.S. Treasury Defaults on its Debt?
What if the U.S. Treasury Defaults on Its Debt?
This is a question that has appeared recently in the national news media since Congress failed to approve a lifting of the U.S. debt ceiling in January. The answer to the question is complicated, but the short answer is that any and all failures of Congress to lift the debt ceiling harm the U.S.
For all of the criticism the U.S. faces for its domestic and foreign policies, the primary reason why our borrowing costs are comparatively low is that the U.S. dollar is regarded as the safest currency on the planet. When we hear the term “flight to safety,” it is often used in conjunction with the purchase of U.S. treasury securities, which are backed by the “full faith and credit” of the U.S. Government (and its tax-paying citizens).
Over the past two decades, there have been multiple instances in which Congress has balked at raising the debt ceiling. With each new instance, global concern over the U.S.’s ability to make good on its debts increases. The latest challenge is no different. On the surface, calls from the Republican party to rein in spending seem rational, but the game of chicken the politicians are playing with the “default card” is, in my opinion, unconscionable. It may be the right conversation, but it is not the right venue.
What is the debt ceiling and what happens if it is not lifted?
The debt ceiling is the restriction on the total amount the federal government may borrow to pay its bills and allocate funds for future investments. The total bill for all the nation’s expenditures is the national debt. In December 2021, Congress increased the debt ceiling to $31.38 trillion. As of January 2023, the treasury department has advised that the U.S. treasury debt was about to hit that mark. In the absence of congressional approval to increase the ceiling, the Treasury does not have the authority to borrow more money (i.e., issue new bonds) to pay its bills. Since Congress failed to approve an increase to the debt ceiling, the Treasury has instituted a number of complex procedural measures to temporarily stave off a technical default. It is generally understood that the Treasury Department's tool kit will be emptied by June or July 2023.
If Congress has not acted to raise the debt ceiling by that time, the next step would be a government shutdown. The purpose of a shutdown is to ensure that all essential government obligations, such as social security payments, payments to military personnel, and interest on treasury debt continue to be paid. In 2023, federal revenue is expected to be around $4.8 trillion while expenditures are expected to be around $5.8 trillion (Source: Center on Budget and Policy Priorities). A government shutdown would be a temporary elimination of government spending on “non-essential” obligations to offset at least the roughly $1 trillion budget deficit.
Since 1990, there have been 6 government shutdowns ranging in length from 3 days to 35 days. The most recent shutdown was the longest. The 35 day shutdown began in December 2018 and ended in January 2020. It resulted in an estimated unrecoverable loss to the economy of $3 billion dollars (Source: Committee for a Responsible Federal Budget). Thus, while a government shutdown may help avert an actual default on the U.S. treasury debt payments, its cost to American taxpayers and to the U.S. government’s credibility is far from inconsequential.
What triggers an actual default on U.S. Treasury debt and what would be the ramifications?
If the economic fallout from a prolonged government shutdown reached the point where incoming revenues were no longer sufficient at which the U.S. Treasury determined it could no longer meet its entitlement spending needs and/or the interest and principal payments on its bonds, then the U.S. would truly be in default. With respect to quantifying the fallout from such an event, to borrow a line from Dr. Egon Spengler in the 1980s classic, Ghost Busters, “It would be bad.” [See Video Clip]
In economic terms, “bad” might not be all that far off from Dr. Spengler’s definition. I don’t know what “total protonic reversal” means, but it can’t be much worse than a global financial collapse.
Since the “D” word has crept back into the political lexicon, I have had a number of people as what investments might protect against such a calamity. The short answer is that there are no great places to hide from a potential hyperinflationary environment in which financial institutions might unilaterally become insolvent. “What about gold?” you may ask. Aside from the fact that gold has been an extraordinarily poor investment for more than half a century, even if gold prices rose in advance of an impending default, it probably might not have much post-apocalyptic value. You cannot eat it.
Is a Default Scenario Likely This Time?
So far, the stock and bond markets appear to be viewing the media headlines as hyperbole. Both the 30-year and 10-year treasury yields remain below 4%, which suggests that there is very little concern that even the most dysfunctional Congress will not be foolish enough to let our cache as the world’s safest investment haven evaporate.
For my part, I continue to encouraging people to allocate their free cash to short-term treasuries with yields in the 4.5%-5.0 % range and have been snatching them up for clients like there really will be a tomorrow.
How worried should we be if the debt ceiling isn’t lifted? (The Brookings Institution)
Will the U.S. Ever Default on Its Debt? (TheBalance.com)
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