The US government is at risk of defaulting on federal debt — the money it has borrowed to pay for the likes of social security, medicare, military salaries and tax refunds. As a result, Joe Biden’s administration is trying to raise the government’s current borrowing cap of $28.4trn, but to do so requires the approval of the Senate — a move which has so far been blocked by the Republicans.
If the bill continues to be blocked, it could lead trigger a “catastrophic event for [the] economy,” said Treasury secretary Janet Yellen when delivering a prepared testimony before the Senate banking committee on 28 September. Yellen believes the government will run out of options for paying off its debt by 18 October if it can’t increase its borrowing limit.
This could mark the first time in history that the US has defaulted on its debts, something that could lead to millions of people losing their jobs while simultaneously endangering government benefits and causing a market crash.
Why are the Republicans blocking the bill?
“There is no chance Republicans will help lift Democrats’ credit limit so they can immediately steamroller through a socialist binge that will hurt families and help China,” said Republican Senator Mitch McConnell.
However, the opposition has been accused of holding the country’s debt ‘hostage’ in an effort to weaken Biden’s presidency. Critics are drawing parallels between now and 2011 when a similar situation arose during Barack Obama’s first term that led to Standard & Poor’s downgrading the country’s credit rating.
“Raising the debt ceiling doesn’t authorise additional spending of taxpayer dollars. Instead, when we raise the debt ceiling, we’re effectively agreeing to raise the country’s credit card balance” - Treasury secretary Janet Yellen
“Raising the debt ceiling doesn’t authorise additional spending of taxpayer dollars. Instead, when we raise the debt ceiling, we’re effectively agreeing to raise the country’s credit card balance,” Yellen said.
Following warnings from Fed chair Jerome Powell, top Senate Democrat Elizabeth Warren, labelled Powell as “dangerous”, and stated that she opposes his reappointment. “The seeds of the 2008 crash were planted years in advance by major regulators, like the Federal Reserve, that refused to rein in big banks,” Warren said as she addressed the Senate banking committee.
Could the markets crash?
John Williams, the president of the Federal Reserve Bank of New York, warned that investors could become “extremely nervous,” reports the Financial Times.
If a market sell-off were to occur as a result of the US defaulting on its debt, it could have a devastating effect on major indices such as the S&P 500 [GSPC] and the Dow Jones Industrial Average [DJI], which are often used to benchmark the performance US economy as a whole.
Both indices have reached new historical highs this year, pointing investor sentiment towards an inevitable downturn. What happens in Washington may be a trigger.
“Stocks continue to trade near their recent highs (only a few per cent away), and it won't take much to send them higher” - Kevin Matras
However, executive vice president of Zacks Equity Research, Kevin Matras believes there’s more potential for growth than a market crash.
“Stocks continue to trade near their recent highs (only a few per cent away), and it won't take much to send them higher,” Matras said, writing for Zacks. “If news out of Washington can't do it, we've got Q3 earnings just around the corner.”
“Full-year growth is still expected to come in at the fastest pace in 37 years,” Matras concluded.
How will Washington proceed?
For now, however, the crisis has been momentarily averted as Biden signed a nine-week stopgap funding bill that has prevented a government shutdown. The legislation, which was rushed through Congress on 30 September, will keep funding levels flat for government agencies and departments. If the bill hadn’t been passed the government would have had to start suspending its operations on 1 October.
Should the situation improve, as a result of the Democrats successfully raising the government’s limit on borrowing or finding another way to avoid defaulting on its debt, the negative effects of a default either won’t come to fruition or will be less severe.
When the last major risk of this happening came about in 2011, Timothy Geithner, then the Obama administration’s secretary of the Treasury, said: “Interest rates for state and local government, corporate and consumer borrowing, including home mortgage interest, would all rise sharply.” Home values, equities and retirement savings would fall, Geithner added highlighting the corresponding threat to jobs and lifestyle.
Investors around the world will undoubtedly be keeping a keen eye on all news coming out of Washington until the issue of its debt is resolved, one way or another.