EThere is a small glimmer of hope after Joe Biden and Kevin McCarthy met. The US President and the Speaker of the House of Representatives met again on Tuesday afternoon (local time) to negotiate raising the debt ceiling. The White House then said Biden was “optimistic,” and McCarthy also indicated that he ultimately expected an agreement.
However, actions have shown that it is more serious than the words suggest. Biden summarily canceled further state visits to Asia after the G-7 summit. Because the United States is running out of time. On June 1st, the world‘s largest economy is threatened with insolvency – at least if the statutory debt limit is not raised by then. Experts warn that even a temporary delay in payment would have devastating consequences for the financial markets and the global economy.
The situation is deadlocked: for raising the lid needs President Biden the approval of the Republicans in Congress. And they are massively opposed to this, as long as a higher debt limit is not accompanied by significant savings in certain government spending. The President, on the other hand, does not want to allow himself to be blackmailed.
Finance Minister Yellen warned of a catastrophe
Before the meeting, US Treasury Secretary Janet Yellen again warned of an “economic and financial catastrophe”. A default would trigger a “global downturn” that would set the world back. And indeed, according to experts, there is a risk of a devastating snowball effect.
Can the US no more Debts take on more, they would have to prioritize their expenses: what will be paid for first with the current income? In order to prevent an immediate collapse, the state should first meet its existing interest rate obligations.
Other payments, from Social Security to federal or military paychecks, would be delayed. The tearing of the upper limit would therefore first be felt by those Americans who receive benefits directly from the state or from state-funded programs. Those affected would have less money available – and are holding back on spending.
But companies that fulfill government contracts could hardly be paid from now on. Yellen recently warned that this would lead to disruptions, for example in air traffic control, law enforcement or border security.
Three million jobs are at stake
The consequence of all this: increasing unemployment. “The United States could shed up to three million jobs,” warned center-left think tank Third Way in a recent report. In the event of a prolonged outage, the White House even expects 8.3 million additional job losses. There would be a recession.
At the same time, doubts about solvency could also shake confidence in US government bonds. Finally, there is a threat that the United States may soon stop paying interest on Treasury securities issued.
The worst-case scenario from the point of view of George Brown, economist at the investment firm Schroders: “There is a sell-off in government bonds, which then spreads to vulnerable bond markets and forces governments worldwide to cut spending,” he explains.
Even more: The US government bonds are actually considered fail-safe securities – and are therefore used worldwide as collateral for loans used. They form the basis of the global financial system. Wall Street experts are therefore warning that the distortions in the government bond market will quickly spread to other markets. In the worst case, there is a threat of a global financial and economic crisis.
A payment default does not have to be
It is still extremely unlikely that such a scenario will occur. Because the reasons for a default by the USA would be purely political – and thus solvable at any time. There has been a statutory debt ceiling in the USA since 1917. This determines how much money the state can borrow. The limit is currently around $31.4 trillion. However, because this cap has already been reached, the US Treasury Department is currently having to tap into capital reserves. The fact that the limit is regularly raised is actually common practice in the USA – this has happened 102 times since the Second World War.
However, even before the deadline of June 1st, the uncertainty surrounding the lack of an agreement could affect the markets. Brookings Institution analysts Wendy Edelberg and Louise Sheiner recently stated that deteriorating expectations alone “would make significant disruptions in financial markets increasingly likely.”
This could be accompanied by falling share prices, but also consumer reluctance to buy and lower demand for credit. During similarly tense negotiations in 2011, the market-wide S&P 500 index fell more than 16 percent in the five weeks before the eventual hike. Many investors, on the other hand, would Gold set as security.
According to a recent survey by the news portal “Bloomberg”, the precious metal is the first choice if the political games in Washington drag on. A majority of 52 percent of professional investors would therefore buy gold in the event of a default.
Election campaign strategy is likely to be behind the difficult negotiations. In the recent past, Joe Biden has repeatedly portrayed Republican demands for spending cuts as unreasonable.
McCarthy also needs a hit
And McCarthy also needs success badly. In particular, the ultra-conservative Republicans in the House of Representatives are putting the 58-year-old under pressure. Earlier in the year, they downright embarrassed him when McCarthy was elected Speaker of Parliament after 15 ballots.
“The problem is that McCarthy, given his weak position in the House of Representatives, is going to have a very hard time finding a deal that satisfies this group of troublemakers and the rest of the Republican faction,” said Michael Strain, economic policy director at the American Enterprise Institute.
The economist therefore warns against playing with fire. Even if the US government and Congress agree at the last minute, an unwanted outage could occur.
Strain cites an example: In the spring of 1979, Congress only agreed to an increase at short notice, but a subsequent computer glitch delayed the Treasury Department in making payments for maturing securities to individual investors. “As a result, interest rates rose and taxpayers had to make billions of dollars in additional payments,” the economist explains.
Should the negotiations actually fail in the end, President Biden would probably still have an ace up his sleeve – at least if you follow the legal opinion of the Democrats. Biden could therefore simply continue to borrow money without a vote in Congress – and use it to pay off debts.
In doing so, he could invoke the 14th Amendment, which states that the “legitimacy” of government debt “must not be called into question”. Such a step would also be unique so far – and therefore by no means certain.