What will happen if the United States reaches the debt ceiling?

WASHINGTON — With congressional leaders seemingly at an impasse over a deal to raise the national debt ceiling, risks are growing that the United States could run out of money to pay all its bills as early as next week — placing the country in uncharted waters as to what happens next.

The debt ceiling refers to a law that caps the total amount of federal debt allowed to be outstanding. The United States hit that limit in January, but the Treasury Department said it used workarounds, or what it calls “extraordinary measures,” to prevent the government from paying its bills on time. .

But Treasury Secretary Janet Yellen says those efforts will run out in the coming week and the United States could run out of money to meet all of its obligations by June 1. The Treasury Department know the exact date, because there’s a constant flow of money coming in and out of federal coffers, but Goldman Sachs predicts the date could be closer to June 8 or June 9, and bipartisan political groups say the date is probably between June 2 and 13.

Regardless of the exact date, without legislative action, the United States is days away from not being able to pay all of its bills, which has never happened before. Like anyone facing a fiscal crisis, Yellen will have to figure out who gets paid and when — until the country receives a new influx of tax payments expected in mid-June, according to the Bipartisan Policy Center. These payments could keep the federal government’s cash flow positive until mid-July.

Yellen didn’t give many details about what specifically would happen once the country’s bills exceeded its income, but economists and former government officials have theories about who might be paid and how.

Creditors on the front line?

One option for Yellen would be to first pay bondholders the interest owed to them on U.S. Treasuries and delay paying all other bills, like Social Security and Veterans’ benefits, until government has enough money to do it, said economists and fiscal policy experts. It was a strategy Treasury officials said they put in place in 2011 when the United States nearly defaulted at the time.

Failure to pay bondholders would likely have the greatest impact on the economy due to the chaos it would create in financial markets, since treasury bills are considered one of the safest investments in the world.

A failure to make those payments would almost certainly trigger a downgrade in the United States’ credit rating, making it more expensive for the government to borrow money and driving up interest rates for anyone looking to borrow. money for a house, a car or with a credit card. , the economists said. It would also force banks to drastically cut lending, cutting lines of credit to businesses that need to borrow money for everything from an expansion to the month’s payroll. The value of the dollar would also be affected, which would have an impact on companies that buy or sell goods abroad.

But even if the United States does not default on its debt payments, the risk of being so close and not being able to make further payments could be enough for rating agencies to lower the rating. US credit rating, as in 2011 when S&P downgraded the US rating. when it got dangerously close to a fault.

Prioritizing payments from bondholders could also have political ramifications for the Biden administration if seen as paid investors while others, like Social Security recipients, miss getting their checks on time. .

“Politically it’s a disaster because you’re effectively paying a Chinese bondholder before you pay someone’s Social Security payment,” said Stephen Myrow, managing partner at Beacon Policy Advisors, who worked at the Treasury Department under the Obama administration.

Delay in government payments

Prioritizing payments outside of what is owed to debt holders becomes more complicated because choosing among the thousands of bills to pay would be a politically, logistically and legally strife business for Yellen and President Joe Biden.

Yellen said the Treasury was not set up to do that and non-payment of any payments — whether to creditors or veterans — would be considered a default.

Given the payment system used by the federal government, it might not even be logistically possible at this point to issue some payments, such as Social Security recipients, and not others, such as federal workers, said Shai Akabas, director of economic policy at the Center for Bipartisan Policy. If some groups were paid and others weren’t, it could also open the administration up to legal challenges.

Instead, political pundits expect Yellen to delay paying all other bills until the United States has enough revenue in its accounts to pay all bills at once. This could mean a delay of several days for those waiting for government benefits, which are expected to go out for some recipients on June 2. The longer the stalemate lasts, the longer the delay will be.

“We assume that the US Treasury would continue to make principal and internet payments on time, but it would defer interest-free payments until it had enough money in the current account to pay all obligations. without interest from that day all at once, not prioritizing them and making sure they had enough money to pay the interest,” said Wendy Edelberg, Hamilton Project Director and Principal Investigator at the Brookings Institution.

The delay in payments would likely be relatively short-lived, as the United States is expected to receive an influx of tax payments on June 15, which could provide enough liquidity to see the country through July before it freezes. is once again running into a cash crunch, Shai said. Akabas, director of economic policy at the Bipartisan Policy Center.

A much larger disruption, however, would likely come from the physiological effects of the United States’ inability to pay all of its bills. Stocks could fall 20% under this scenario, similar to declines seen during the 2008 financial crisis, according to a UBS report.

What is the difference between a fault and a shutdown?

A breach of the debt ceiling would be different from a government shutdown in several respects and would have far greater consequences for the economy than a shutdown, which the United States has experienced on several occasions in recent years.

“We know what a government shutdown looks like, we’ve been there before, it doesn’t look pretty but it’s not catastrophic either,” Akabas said. “With the debt limit, this is totally uncharted territory and we could see ramifications that would affect every American household.”

A government shutdown is triggered when Congress fails to pass legislation to fund the government. As a result, federal workers are not being paid, non-essential workers are staying home, and some services that receive federal funding, like national parks, are closed. But mandatory programs, like Medicare and Social Security, aren’t affected.

But if the debt ceiling is exceeded, all federal spending is affected, including Medicare payments, Social Security checks and veterans benefits. Federal workers would likely still be required to report to work, but might not be paid on time.

Coins and the 14th Amendment

Several workarounds have been proposed by economists and former policymakers, but Yellen and other senior administration officials have largely dismissed them.

One proposal was the minting of a $1 trillion platinum coin by the U.S. Mint that the Treasury could deposit with the Federal Reserve. A 1990s law gives the Mint the power to produce coins of any denomination, but Yellen called the move a “trick” and Federal Reserve Chairman Jerome Powell said he doesn’t. would not accept the part.

The Treasury could also reissue bonds, auctioning old bonds at a higher rate, which would help bring in extra money without adding debt. But economists have said this new form of debt could create chaos in financial markets that could be as bad as what would be seen in a default.

Another proposal has been for Biden to invoke the 14th Amendment which says “the validity of the public debt is not to be questioned,” which some have interpreted as saying the debt ceiling is unconstitutional. According to this interpretation, the United States can continue to issue debt to raise funds, assuming that investors are ready to buy it and confident that it will be held up in court.

Biden said he considered invoking the 14th Amendment, but acknowledged he would likely end up in court, essentially defaulting while the decision is challenged.

Another option would involve congressional action. If House Speaker Kevin McCarthy is unwilling to introduce a bill to raise the debt ceiling without the funding cuts demanded by Republicans and opposed by Democrats, a majority of lawmakers could present it themselves. There is unlikely to be enough support for this so-called waiver or time request option given the lengthy process involved.

Even if any of these proposals were acted upon, they still do not circumvent the larger psychological effects that would occur in global financial markets if the United States were in a position where it could not pay all of its bills. , Edelberg said.

“All these workarounds that people think of, these don’t solve the basic problem that down the road you’re going to have all this dismay because we can’t even do this basic level of governance and meanwhile , it’s all up to the court to determine whether certain issued treasuries were issued illegally,” Edelberg said. “None of these workarounds avoids the worst of the problem.”