Opinion: This federal debt-limit standoff could be really disastrous

I have one message for those observing or involved in the standoff over raising the U.S. federal debt limit: Be afraid, be very afraid. At this point in the financial and economic cycle, the consequences of failing to reach a deal would be particularly dire.

The risks that a political impasse will force the U.S. government to renege on its obligations keeps rising as time marches on with no negotiation or progress. Worse, both sides’ positions appear to be hardening. House Speaker Kevin McCarthy’s ability to pass a budget bill (by the thinnest of margins) has strengthened Republicans’ belief that they can win concessions from the Biden administration — concessions that are actually anathema to the latter.

The Republican legislation would undo several of Biden’s major policy initiatives, including student loan forgiveness and funding for the Internal Revenue Service to improve tax compliance. It would add new work requirements for programs such as Medicaid and slash domestic discretionary government spending. In return, it would raise the debt limit by $1.5 trillion or until March 31, whichever comes first — granting Republicans the opportunity to demand further concessions next spring.

Democrats don’t want to negotiate under duress. The Biden administration argues, reasonably, that the United States needs to honor its obligations: If Congress doesn’t like the way its tax and spending policies increase the country’s indebtedness, it should deal with this through the annual budget process. This is why the debt limit has almost always has been raised (with the notable exception of 2011) without requiring budgetary concessions, including repeatedly during the Trump administration.

In the game of chicken, the idea is to hold out as long as you can, to scare your opponent into conceding. So the standoff will almost certainly go to the very last moment, when the Treasury runs out of capacity to keep paying its debts in full. That date will likely be either early June or sometime in late July or early August. The federal government gets considerable revenue in mid-June from corporate and personal income tax payments, so if the Treasury can make it that far, it will have enough cash for another six weeks or so.

A full-on collision is entirely possible, given how far apart the two sides remain on how to limit future budget deficits. The Democrats favor increasing taxes on the wealthy and improving compliance. The Republicans favor sharply cutting domestic discretionary spending. The only area of agreement is that Social Security and Medicare are off limits. Meanwhile, McCarthy has troublingly little room for maneuver: If he brought any legislation to the House floor that Democrats in the Senate had agreed to, he could lose his job as speaker.

The damage would be vast. Markets would be shocked. Stock and bond prices would decline violently, Treasuries would gyrate as investors worried about how long the payment prioritization would protect them, and money market mutual funds might pull out of government debt en masse.

The sudden stop in payments would also weigh heavily on an economy already on the verge of recession. If it happened in early June, it wouldn’t be as bad because there would be an immediate, temporary respite as mid-June tax payments came in. If it came in late July or early August, as appears more likely, the spending cut would be huge and sustained. If legislators didn’t relent quickly, the combination of market panic and forced austerity would send the economy off a cliff.

One can only hope that sanity will prevail. But given the vast political divide and the narrow margins in the House and Senate, it’s not obvious how this will occur.

Bill Dudley, a Bloomberg Opinion columnist, is a senior research scholar at Princeton University’s Center for Economic Policy Studies. ©2023 Bloomberg. Distributed by Tribune Content Agency.

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