Can the war on debt limit really cause a recession? The risk is not what you think.
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About the author: Christopher is smart is chief global strategist and head of the Barings Investment Institute, and a former senior official for economic policy at the U.S. Treasury Department and the White House.
Let’s stipulate that “debt limit” is an eerie legal relic turned into a self-defeating political baton. Failure to raise the debt limit later this summer would undermine Washington’s global leadership role, tarnish its political model and bolster Beijing’s narrative that the United States is a crumbling superpower .
But will it really cause a “major recession” and “push us into a deep hole for a long time,” in the words of President Joe Biden? warning? It will “devastating” banks and economies like Finance Minister Janet Yellen suggest? Will it create a chaotic run from the dollar globally and forever increase the cost of American borrowing? It’s really not sure how bad the damage could be other than creating new volatility into the market. But what is clear is that if the government’s rhetoric proves exaggerated, the next time it will encourage political opponents to wage a much more disastrous confrontation.
Just experienced the biggest one-day drop in 2-year Treasury yields since 1982 With the failure of a bank that even the most savvy investors can’t name, there’s certainly a sense that the current market turmoil could easily turn into something big. than.
However, the next scheduled crisis is unlikely to be a full-blown disaster because it is already scheduled. Not only did we know a debt limit “crisis” was coming, but we also knew it was mostly for show. People of all political parties believe that America’s debts should be respected. Washington did not refuse to pay, but only refused to borrow.
If you owned Treasuries, would you really rush to sell them if you were sure you would be perfected? Furthermore, if you were to sell the most liquid securities in the world, what would you buy instead?
For the foundation, the debt limit first passed in 1917 for the convenience of Congress had previously authorized not only the quantity of each new debt issue, but also the determination of interest rates and maturities. The more recent practice of using this vehicle to extract presidential spending cuts dates back to 1995, when a confrontation between House Speaker Newt Gingrich and President Bill Clinton ended in political government shutdown lasted several weeks.
It is also not entirely true that the US government will be involved. unprecedented territory due to failure to pay the debt on time and in full. After the War of 1812, declining revenue made it impossible for the government to pay its bills, and in 1933 the Roosevelt administration canceled the bond terms that promised interest in gold. A computer glitch in 1979 led to delays in processing 4,000 interest checks due by individual bondholders.
This time around, we’ve entered a phase where the Treasury has taken “extraordinary measures” for several weeks to keep its spending below its current limit of $31.4 trillion, including through the adjustment of the pension fund of government employees. But at the end of the summer, “XD” as it is called, will come. Unable to borrow more, the Treasury would not have enough to pay all the bills. Neither the Republican House of Representatives nor the Democratic administration have any incentive to agree to anything before the last minute.
Treasury says it has do not have the authority or the ability to prioritize retirees over defense contractors or bondholders over government salaries. Government report on a pre-debt limit deadlock found that the Treasury would pay any obligations due as soon as sufficient cash was available, potentially causing a growing backlog of late payments.
The Treasury Department’s failure to pay bondholders up front can be stressful, but the question is how much damage will come from a few days’ delay in interest payments. The rating agencies may downgrade the US debt rating – again, this is not the first time – but the regulators will likely waive any requirement that could lead to a forcion. sell the most liquid assets in the world. Short-term bills will see the biggest disruption, but the Federal Reserve has proven tools to maintain order in the money markets.
If the world were fair, then the market would actually punish the US for defaulting on its debt and demand higher interest rates until confidence returns. But financial markets are largely unknown to “justice,” and the fact that a few days stalemate between the White House and Congress will have little effect on expectations that the United States will actually pay. . Recall that when Standard & Poor’s downgraded the U.S. debt rating after the 2011 strike, the world’s most liquid assets actually recovered.
Of course, there are many underlying factors in the global financial system that could make the outcome much worse, but the base case should still be a brief market disruption ending in a deal. financial agreement.
And that is the real problem that investors should worry about.
Sadly, this won’t be the last pass of the debt limit. A relatively benign outcome would only encourage those in Congress who may believe more disruption will be needed to bring attention to their concerns. The greatest danger comes when not only is breaching the debt limit and “special measures” traditional, but blowing up the ‘X-day’ has become the norm. That’s when a few days of market disruption turn into a few weeks.
It may not come with the next debt limit battle or the one after that, but one day bondholders will slowly begin to seek compensation and look for alternatives. That’s when the damage to America’s credit and costs to taxpayers can become permanent.
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