As Congress decides whether to raise the debt ceiling in the coming months, for the first time in United States' history, there is real talk of sending the country into default. Many Republicans are saying they will not vote for raising the debt ceiling under any circumstances, and even those who say they might vote for it also say it will need to be accompanied by serious cuts in programs, like Social Security. Most Democrats have said that Social Security and Medicare are off limits. If some kind of agreement to raise the debt ceiling is not reached, the United States eventually will default on its loan obligations.
Under such a scenario, the Treasury Department and White House could try to delay the inevitable default for a short time period. The Treasury could shift around some money, and if the Obama administration shuts down many federal agencies hitting the roof of the debt ceiling might be avoided for a few weeks. Withholding reimbursements for Medicare and Social Security checks would also help, though the political consequences of such actions would be significant. Eventually, however, the inevitable would arrive, due to bills for critical defense operations, interest payments, and other obligations of the country. Much like many individual Americans have done over the past decade, the United States government would have to go to our creditors and say we cannot make the payments on our debt. Many of the creditors are Americans themselves.
The trillion dollar question then is "What happens next?" The best answer is that no one knows for sure. Everyone agrees the results would not be positive. No country the size of the United States has every gone into default on its debt. The financial markets lost a ton of value when Greece was perceived as being in danger of default in 2010. Greece has a GDP of $329.9 billion. The United States has a GDP of $14.12 trillion. Many believed the global economy would have collapsed had Greece gone into default. One can only imagine what would happen if the United States defaulted on its debt.
Having said that, there are some signs of what can be anticipated, based on the Greece example. Markets prefer to anticipate rather than react to events. The markets did not wait for Greece to default; instead, the world financial markets started freaking out before the anticipated worst-case scenario. In the same way, financial markets likely will start experiencing serious problems in the month before the U.S. government defaults, if the debt ceiling is not raised. Right now the debt ceiling is set at $14.294 trillion dollars. The current federal debt is $13.886 trillion and rising by about $4 billion each day. That gives Congress about 100 days to raise the debt ceiling, which means the world financial markets should start getting nervous by late March if nothing is done.
The debt is not just numbers; it is real money that has been lent with real expectations of returned payment. The debt is owed to multi-national banks, foreign countries, and the public itself through treasuries. If an individual defaults on a loan, the debt does not disappear. Instead, the bank takes the loss. If the United States goes into default, much of the world will suddenly face the prospect of losing about $14 trillion dollars. The results likely will be catastrophic.
Many of the world's largest banks, which are still hardly on solid footing after the 2008 financial crisis, would go bankrupt due to their exposure to the United States. Credit for simple things like houses and car loans may become unavailable as a result. Most large companies use short-term credit to make their payrolls. That credit would disappear, and as a result, many workers would have to start going without a paycheck. There is a very real possibility that people would go to their local bank or ATM and not be able to withdraw cash from their account. Hyperinflation could very likely ensue as the United States dollar becomes basically worthless. The "full faith and credit" of the United States is the only thing holding up the value of the dollar, so when that credit is gone, it is hard to imagine the dollar's surviving with it.
In response to the crisis, businesses would once more lay off workers, only worsening matters and creating a downward economic cycle, which results in a depression. The stock market would plummet as well, negatively affecting the 401(k) accounts of millions of Americans. The price of oil would skyrocket, and with it likely the price of gasoline. Ironically, the only people to benefit may be the firms which invested in the kind of credit default swaps that caused the 2008 financial disaster.
It is this kind of scenario which led White House adviser Austan Goolsbee to declare the mere talk of default "insanity." As Goolsbee put it, the United States is not in real danger of default. While in the long-term, the federal debt certainly does pose a problem, currently the United States can still easily meet its debt obligations. If the United States goes into default, it will not be because of the economics, but because of the politics behind the issue. The consequences of that political game could have dramatic effects on the United States' economy in the years to come.
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