The Debt Ceiling Crisis

Susan Jung |

You will likely continue to hear news about the debt ceiling up until resolution of the issue. I thought it might be helpful for you to review a few potential consequences of the debt ceiling not being raised. This was succinctly covered in a recent U.S. News & World Report article listed below. I think you’ll find this information interesting. I believe the debt crisis will be resolved either prior to expiration or very quickly afterwards; It’s a game of chicken at this point.
Markets may shutter initially, but as we have witnessed in the last three debt crisis dramas, markets have been surprisingly resilient. There may be real impact on the economy and that is why we are factoring into our perspective that the U.S. economy will enter a shallow recession sometime this year. We are investing accordingly.


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“What Happens if the Debt Ceiling Isn’t Raised?

The extent of the damage would depend on whether the government actually defaults on its debts, but it could call into question the supremacy of the U.S. in the world economic order.

Here are some of the possible consequences of a default:

1. Slashed Government Services

If the U.S. goes into default – or runs up against the deadline – the government will have difficult decisions to make. The law will require the U.S. to continue payments for entitlement programs such as Social Security and Medicaid, while at the same time denying the government the ability to borrow in order to pay for them. Even with the most extensive cuts imaginable to domestic discretionary spending, the government would have to prioritize spending and likely halt many cherished programs.

2. Higher Interest Rates

Already, the bond market has seen yields plummet on the shortest term debt, such as one-month Treasury bills, as the risk of default increases. Sell-offs of U.S. Treasury bonds will likely see rates become volatile across the board, according to economists. That could mean higher mortgage rates and borrowing costs for everyone, adding to inflation and placing further drag on an economy now in slowdown. And even if the default is only temporary, it could mean higher borrowing costs for the government, further worsening the nation's fiscal situation.

3. Market Panic

Economists fear that as interest rates are skyrocketing and debt holders are unloading their bonds, it could create a market panic similar to the stock market crash of 2008 – but possibly worse. No one knows for sure what would happen – the U.S. government has never gone into default – and the unpredictability would fuel the market unrest.

4. Run on Money Market Funds

Some analysts are worried that the threat of a default will cause a run on money market accounts. Such a run was a key ingredient to the stock market crash in 2008. If a large fund has to halt redemptions, as happened in that instance, it would worsen the panic and possibly require the government to step in to stabilize the markets. One complication: There has already been a massive switch into money markets from bank deposits following the failure of Silicon Valley Bank in mid-March.

5. Political Instability

The standoff over the debt ceiling comes as the 2024 presidential field is beginning to take shape and as vulnerable lawmakers up for reelection in swing districts seek to appease their bases, putting debt limit maneuvers under the microscope.

But both sides seem to already be employing a messaging strategy targeting the tactics of the other, deepening a chasm of political divisions in the country. While Democrats have accused Republicans of holding the economy “hostage” and proposing funding cuts to programs that benefit the most vulnerable, the GOP has taken aim at the left’s “reckless” spending and its effect on the economy more broadly, making clear that raising the debt ceiling without cutting spending would be irresponsible.

6. Long-Term Effects

Even if Congress eventually resolves the fiscal impasse, a default could lead credit rating agencies to permanently downgrade U.S. debt, and the impasse could have long-standing effects on America's economic standing in the world, as well as the dollar's status as the world's reserve currency. The dollar has come under pressure recently, largely as a result of the Federal Reserve’s interest rate hikes and geopolitical realignments stemming from Russia’s invasion of Ukraine. Foreigners are major holders of U.S. debt and they could choose to sell, putting further pressure on the bond market.”

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