Announced US default caused economists to panic: “The sky will collapse”

The jobs, benefits, and financial security of millions of Americans could all collapse as early as June 1st. US Treasury Secretary Janet Yellen on Monday issued a stern warning that the US government could run out of money to pay its obligations by the first day of summer if Congress does not increase its borrowing authority. Failure to do so could trigger domestic and international financial disaster.

“If Congress fails to increase the debt limit, it will create serious hardship for American families, damage our global leadership, and raise questions about our ability to protect national security interests,” Yellen wrote in a letter to House Speaker Kevin McCarthy.

President Biden has been quick to respond to such statements by calling for congressional leaders (including Speaker of the House Kevin McCarthy) to discuss a White House debt ceiling increase.

In this whole situation, it may not be entirely clear why the problems with the debt ceiling arose at all and what it even is. Let’s try to explain.

The debt ceiling set by Congress is the maximum amount the federal government can borrow to finance obligations already approved by lawmakers and the president when the government runs a budget deficit and the revenue it collects is insufficient. The debt ceiling, which currently stands at $31.4 trillion, was set over a century ago and has changed over 100 times since World War II.

While it was originally designed to make it easier for the federal government to borrow, the cap has become a way for Congress to limit the growth of that borrowing, turning it into “political football” in recent decades. Fear of an impending default has prompted lawmakers to pass legislation to raise or suspend the debt ceiling each time, most recently in December 2021. Thus, the US never actually defaulted on its debt. But, as you know, there is a first time for everything.

On the one hand, finding common ground between the Republicans and Biden in the negotiations is the only possible option and this time to avoid a default. However, not all so simple. The gap between the parties remains huge. Biden hasn’t met with Speaker McCarthy since February, even as the House of Representatives passed a $1.5 trillion debt-ceiling package last week.

The bill also included cuts in federal spending, increased requirements for work on welfare programs, and other measures that Democrats reject. This became a breaking point between conservatives and democrats. Significantly, after the bill was passed in the House of Representatives, President Biden told reporters that he “would be happy to meet and talk with McCarthy, but not about whether the debt limit will be raised.” The White House says the president will only accept a “clean” proposal to raise the country’s borrowing limit. This veiledly indicated that no reciprocal steps from the Democrats should be expected.

What happens if all funds are exhausted? The Treasury Department is likely to have to temporarily delay payments or default on some of its obligations, US analysts say, potentially impacting US interest and principal payments, Social Security payments, veterans’ benefits and federal workers’ wages. A default would also hurt the US economy and global financial markets, as well as shake confidence in the security of the Treasury market and raise borrowing costs.

To prevent a default, the Ministry of Finance may take emergency measures (a kind of behind-the-scenes accounting maneuvers of the department). Treasury secretaries are authorized by Congress to take several types of emergency measures to prevent default, giving lawmakers more time to increase or suspend the limit.

If you recall, back in January, Janet Yellen announced the termination of investments in the Government Securities Fund due to the achievement of the ceiling of the country’s public debt. As explained in a letter to Kevin McCarthy, the Government Securities Fund is part of the federal employee’s pension system, and the suspension of investments in it is necessary to prevent the state debt from exceeding the established level. All these actions were aimed at ensuring that the proceeds from this fund are counted in favor of the debt limit.

The Treasury’s action will reduce outstanding debt subject to the cap and temporarily give the agency more room to continue funding federal government operations.

It so happened that America was faced with two crises – banking and debt. With the first one, everything should be clear: already three banks (earlier Silicon Valley and Signature Bank declared bankruptcy, and on May 1 First Republic Bank, which is one of the twenty largest financial and credit organizations in the United States), have declared bankruptcy, but , however, did not frighten the citizens of America too much. Yes, and Biden assured, they say, the banking system is “safe and sound.”

In general, American analysts admit, it’s a shame, but it’s not a disaster. All the events with banks only forced to look more closely at the supervision of financial institutions, and also caused distrust of leading economists in the Federal Reserve System.

As for the debt crisis, here experts express great concern, because, whatever one may say, this issue is closely connected with politics. Justin Wolfers, a professor of economics and public policy at the University of Michigan, told CNN: “There are big concerns that this generation of lawmakers is more irresponsible, more polarized and more prone to damage than any previous generation. At some point in the very near future, we will come to the conclusion that Biden and McCarthy, along with other leading Democrats and Republicans, will have to come together to avoid default or deal with the consequences of its occurrence. The question is, will the economy suffer in the meantime… At this point, more than ever in my career, I worry that the sky is really going to fall.”

And these words also did not come out of nowhere. For example, on April 16, the head of the European Central Bank (ECB), Christine Lagarde, said on CBS: “I just can’t believe that they allowed such a big, big catastrophe because the United States of America defaulted on its debt. This is impossible. But if this happens, there will be very negative consequences not only for this country, where confidence would be shaken, but for the whole world.”

Lagarde added that if Democrats and Republicans fail to resolve the stalemate over debt alignment, there will be global repercussions. In this regard, the head of the ECB called for pushing political sentiment into the background and observing the “supreme interests of the nation.” Janet Yellen has also warned at different times that if Congress does not agree to raise the debt ceiling, then the US will face a financial disaster.

So far, there is little hope that the Democrats or Republicans are ready to give in first in favor of the interests of the country. The Democrats are demanding that “clean” increase in the public debt without additional conditions, while the Republicans insist that it is impossible to achieve an effective increase in the public debt without reducing certain federal spending. Accordingly, it will be impossible to avoid default. Is McCarthy ready to talk to Biden? Doubtful. Now the speaker is not even in the US, but in Israel. And in response to warnings, Yellen only states: “President Biden refuses to do his job, threatening to bring our nation to the first default in its history. The clock is ticking.”

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