The risk that a political stalemate will force the United States to default on its obligations continues to increase as time passes without negotiations or progress. What’s worse, positions on both sides seem to be hardening. House Speaker Kevin McCarthy’s ability to pass a budget bill (by a small margin) bolsters Republicans’ belief that they can extract concessions from the Biden administration, concessions that are actually a sentence for the Administration.
If it were up to Republican lawmakers, they would have defeated several of Biden’s major policy initiatives, including student loan forgiveness and funding for the Internal Revenue Service to improve tax compliance. They would add new work requirements for programs like Medicaid and reduce domestic discretionary government spending.
In exchange, they would raise the debt limit by $1.5 trillion or until March 31, whichever comes first, giving Republicans the opportunity to demand more concessions next spring.
Democrats don’t want to negotiate under pressure. The Biden administration argues, reasonably, that the United States must honor its obligations: If Congress does not like the way its tax and spending policies increase the national debt, it must address it through the annual budget process. This is why the borrowing limit is almost always increased (with the notable exception of 2011) without requiring budget concessions, even repeatedly during the Trump Administration.
In the game of chicken, the idea is to hold on as long as you can scare your opponent into giving up. Therefore, it is almost certain that the confrontation will continue until the last moment, when the Treasury is left without the ability to continue to pay fully on its debts. That date is likely to be in early June or sometime in late July or early August.
The federal government received a significant amount of revenue in mid-June from personal and corporate income tax payments, so if the Treasury manages to go that far, it will have enough cash to last about 6 more weeks.
It is entirely possible that there will be a total collision, given the distance the two sides are keeping on how to limit future budget deficits. Democrats favor raising taxes on the wealthy and improving compliance. Republicans favor reducing domestic discretionary spending. The only area of agreement is that Social Security and Medicare are out of the bargain.
Meanwhile, McCarthy has a small leeway: If he introduces any legislation in the full House that Democrats in the Senate agree with, he could lose his job as president.
If the debt limit ends up binding, it is highly unlikely that the Biden administration will resort to tricks like issuing a $1 trillion coin or invoking the 14th Amendment (which states that “the validity of the public debt of the United States… will not be questioned“). Instead, the Treasury would prioritize obligations, put interest and principal on government securities first to avoid a sovereign default, and defer other types of payments (for example, to government workers and contractors).
Even if the priority had prevented an immediate default on the Treasury instrument, the damage would have been enormous. Markets, still dealing with the fallout from a series of bank failures, should be surprised as they expect the usual last-minute deals to be struck. Stock and bond prices would fall sharply, Treasury instruments would fluctuate as investors worried about how long priority payments would protect them, and money market mutual funds could run out of government debt en masse.
The sudden suspension of payments would also weigh heavily on an economy already on the verge of recession. If it happened at the beginning of June, it would not be so bad because there would be a temporary and immediate relief as the tax payments come in the middle of June. If it happened at the end of July or the beginning of August, which seems more likely, the cut in costs would be large and sustained.
In July and August last year, the federal government’s budget deficit was more than 200 billion dollars. Cutting that amount would represent a fiscal adjustment of about 10 percentage points of gross domestic product. If lawmakers don’t let up quickly, the combination of market panic and forced austerity would send the economy over a cliff.
One can only hope that sanity prevails. But given the great political divide and the narrow margins in the House and Senate, it is not obvious how that will happen.
