As negotiations continue in Washington over the debt ceiling, many are warning of the potentially devastating consequences of a default on U.S. government bills. Even if a last-minute deal is reached, prolonged uncertainty could drive up borrowing costs and destabilize already volatile financial markets, leading to setbacks in business investment and employment and stymying public works financing. Moreover, this conflict could undermine long-term confidence in U.S. stability, with long-lasting effects on investors. Consequently, investors are beginning to demand higher interest rates. If investors lost confidence in Washington leaders, they could panic, and the many vulnerabilities in the banking system could cause widespread problems. A sudden rise in interest rates would be a big problem for companies with large amounts of debt, and a widespread drop in stock prices would undermine consumer confidence, deplete public resources and inflate the cost of living, thereby forcing consumers to take on more debt.
Moreover, the smooth functioning of federal agencies is already a headache for state and local governments, and a prolonged process could stall large infrastructure projects. The United States has the lowest borrowing costs in the world because governments and institutions prefer to hold their wealth in dollars and government bonds, financial instruments that are not considered at risk of default. Over time, however, these reserves are beginning to migrate to other currencies, and ultimately, another country may become the preferred port for large cash reserves.
Credit rating agencies could downgrade U.S. government bonds again, as they did in 2011 when they downgraded U.S. government bonds from AAA to AA+ even after a deal was reached and the debt ceiling was raised. Although it is unclear what will happen if X dates go by, experts predict that the Treasury will continue to make interest payments on debt, but delay other obligations, such as payments to government contractors, veterans and doctors treating Medicaid patients.
It is not clear what will happen if X dates go by, but most experts predict that the Treasury will make interest payments on debt but delay other obligations, such as payments to government contractors, veterans, and doctors treating Medicaid patients. However, Brookings Institution economist William G. Gale said, “These are all defaults, just different groups of defaults.” In 2011, the Budget Control Act led to a decade-long financial crisis, with the cap criticized by progressives, which prevents the federal government from responding to new needs and crises. The economic turmoil from the debt ceiling conflict comes at a delicate time when Federal Reserve policymakers are trying to keep inflation under control without triggering a recession.