It’s no secret that politicians aren’t seeing eye-to-eye right now when it comes to the federal budget. As a result, we currently find ourselves two weeks into a partial government shutdown.
As the president, the Senate and the House of Representatives attempt to reach a deal on the federal budget, another issue looms over Washington, D.C. Current projections indicate that the United States will reach its debt ceiling around the middle of October. Without an increase, there could be more financial consequences for the government of the United States.
What Is the Debt Ceiling?
Since the US government spends more than it takes in ($900 billion more in 2013) it has to borrow to pay for the difference. To ensure the United States doesn’t rack up wild amounts of debt (relatively speaking), Congress needs to authorize an increase in the US debt ceiling (limit) once the borrowing cap is reached.
In other words, it’s the like United States government puts everything on a credit card. Right now, we’re very close to our credit limit. In order to keep paying for things that the government needs, Congress needs to authorize a credit limit increase.
Why Is This Important?
The actual borrowing that the US does to cover the budget deficit is in the form of treasury bonds. These are regarded throughout the world as being one of the safest, most reliable investments there is. After all, the US always pays its bills, including interest on these treasury bonds.
If Congress doesn’t vote to authorize an increase in the debt limit, the United States wouldn’t have the funds necessary to meet its financial obligations, including interest on treasury bonds. Given the stalemate over the federal budget, there’s cause for concern that lawmakers will not be able to reach a deal to raise the debt ceiling, and thus keep the government line of credit flowing.
What Happens If a Deal Isn’t Reached?
Unlike the current situation with the government shutdown, the United States has never failed to raise the debt ceiling, nor has it defaulted on its financial obligations. Since we’re heading into uncharted financial territory, no one is really certain what will happen for sure if the US goes “past due.”
“It’s tough to say what would happen if the US doesn’t raise the debt ceiling because we can’t know how it would play out,” says Bob Walters, Vice President of Capital Markets for Quicken Loans. “Would they make payments on the debt and to social security recipients and military folks, and not pay everyone else? Would they not pay anyone period? If they choose to pick and choose winners, things could be uneven and strange.”
If the US defaults, there is plenty of speculation on what could happen. The U.S. Department of the Treasury recently released a report warning politicians of the severe impacts to the economy if a deal cannot be reached. Here’s what they predict:
- Consumer confidence could fall – So much of the financial system is dependent upon the outlook that investors have. If the United States defaults, outlook among businesses and consumers would likely turn sour. A bad outlook means people would likely hold onto their money because they’re worried about what might happen. When people hold on to their money, they’re not spending it. When they’re not spending it, they’re not buying things that companies produce. That means the companies that produce things aren’t selling them, which is bad news for a consumer economy.
- Stock markets could plunge – Even the threat of a debt ceiling issue was enough to panic investors back in 2011. The potential impact of a US Government default triggered a massive selloff of stocks as investors sought to limit the economic damage to themselves. If the threat of a default spooked people that much, imagine what an actual default could do.
- Wealth could be destroyed – Think of the all of the money you might have tied up in a brokerage account, your 401(k) or other investments. A massive sell off like the one predicted if the US defaults could cause the value of those investments to plummet. As a result, that nice chunk of change you have socked away in your retirement account could be worth less, maybe a lot less.
- Interest rates could spike – The better your credit, the lower your interest rates. Same goes for the government. The reason why the government enjoys such low interest rates is due to its sterling credit history. Well, if it misses a payment, that credit rating would fall, which means it would borrow money at a higher rate. Since interest rates on most consumer loans (auto, business, and mortgage) are tied to the treasury rate, you’d almost certainly see across-the-board increases.
Regardless of what side of the political spectrum they fall, experts agree that a default would be bad for the US economy. It’s really a question of how bad.
Bob Walters agrees.
“If the debt ceiling isn’t raised for more than a few days, things could get very ugly – very quickly.”