Why You Should Care About the Debt Ceiling Debate

DailyWorth

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In just two days, the U.S. government will run out of money to cover its bills unless Congress votes to raise the debt ceiling.

Whether that will happen is still unclear. But a 48-hour resolution seemed increasingly unlikley on Tuesday after the House of Representatives and the Senate introduced competing plans. Even if lawmakers are able to stop squabbling and resolve their differences before Thursday, Bill Hampel, chief economist at the Credit Union National Association, says "consumer confidence is likely to take a major hit." And that could slow the economy for the rest of the year. 

But the impact will be even more severe if more time passes without action. Here's why.

If Congress fails to raise the debt ceiling, the government will be in default, which could mean it will not pay the holders of public debt, such as Americans who own government bonds or foreign countries like China, which hold U.S. Treasury securities. Alternatively, the government could be in “technical default,” meaning it would stop paying its other financial obligations, like federal grants for Head Start preschool programs or Social Security and Medicare payments, says Edmund Moy, chief strategist at IRA provider Morgan Gold.

Because of the implications of a government default, experts say the debt ceiling debate is more crucial than the current government shutdown. A default could destroy the faith investors’ place in the U.S. government. “If holders of U.S. debt, both here and around the world, do not receive the interest payments they had been expecting, this would likely permanently destroy the United States’ preeminent position in world financial markets as the last safe place to invest in times of uncertainty,” Hampel says.
 
Because the U.S. dollar is no longer backed by gold, it is backed by creditors’ “full faith that the United States will be good on paying back the money it borrows,” Moy says. “If that [faith] is damaged, then our credit rating gets lowered and our borrowing costs increase. But also, U.S. prestige takes a huge hit and clears the way for other countries to wean their dependence on the U.S. dollar and argue for a market basket of currencies.”

Ouch. And you could feel the impact directly.


If the U.S. government defaults on its obligations, several immediate changes would occur, which could directly affect you. For instance:

  • Delayed payments. “In the short run, many people who were expecting payments, such as Social Security recipients, military and civilian retirees and health care providers, would not receive them [on time],” Hampel says. Assuming the debt ceiling will eventually be raised, the government would “quickly restore those payments,” Hampel adds.
  • Higher interest rates. The federal government would need to raise interest rates “to prevent a currency crisis,” says David Sussman, CEO of financial consulting firm Valcor Worldwide. (That means higher interest on loans and mortgages.)
  • Housing market woes. Higher interest rates will likely cause the housing market to stall and “in some cases, collapse again,” Sussman says. Because the real estate market is localized, there may be “improvements in some areas with stagnation in others,” Sussman adds.
  • Higher inflation. The cost of commodities, food and other products “would all go through the roof,” Sussman says. “This would cause the devalued dollar to go into a massive inflation run. Cost of living would go through the roof, while wages, entitlements and savings all stay the same.”
  • Decreased lending. Similar to following the 2008 financial crash, banks and capital management firms would stop lending money, which would be especially damaging for small businesses. “Cash flow would cease, and we would see massive defaults in monies owed from consumer and small businesses to their creditors.”
  • Stock market dip. The uncertainty surrounding the debt ceiling debate and a potential default is likely to cause a sharp drop in the stock market, Hampel says.

Together, these results could send the U.S. economy into another recession, especially if the debt ceiling is not raised within a few weeks, Hampel says. “If the debt ceiling were not raised for several months, the recession would likely be as bad or worse than the Great Recession we are just now recovering from,” he says.
 
So how to prevent that? 

Basically, Congress has three choices: It can raise the debt ceiling, default on some payments or immediately balance the federal budget, Hampel says. “Immediately balancing the budget would require a sharp cutback in total federal spending, eight times more than last spring's sequester,” he adds. “That would push the economy into a recession.”

While the jury is still out, most economists do not expect a default to occur, “no matter how irresponsible both parties are acting,” Sussman says. We’re keeping our fingers crossed.

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