By Ann Sapphire and Dan Burns
WASHINGTON — A battle between Republicans and Democrats over the debt ceiling could push the U.S. economy into a recession, even if the standoff doesn’t actually trigger a debt default, analysts say — and a much worse downturn with perhaps 7.5 million people dying being thrown out of the crisis work when they can.
Some corners of the huge US debt market are already feeling severely constrained after Treasury Secretary Janet Yellen said on Monday the government could run out of money to keep its bills on track — be they foreign or international — by early June domestic investors in government bonds, federal employees and contractors or Social Security retirees.
Total government spending averages about $525 billion per month. A small portion of that, about $225 billion in the first quarter, is deficit spending.
Hitting the debt ceiling would mean the government could no longer support this budget deficit, dealing an immediate blow to millions of Americans who depend directly or indirectly on federal funds.
Market impotence from an unprecedented US default would bludgeon billions more in wealth.
And while analysts have suggested a few workarounds to keep the cash flowing, including invoking a constitutional provision that would likely be challenged in court, all are untested.
Investors take the risk seriously. Yields on government bonds worth up to $650 billion maturing in the first half of June rose to record highs following Yellen’s announcement, reflecting the increased likelihood that they may not be repaid on schedule.
The cost of insuring US Treasury bonds against default has rocketed to its highest level since the 2007-2009 financial crisis.
“I don’t think there are many people in the market who would bet heavily on a default happening. Most people I speak to believe there will be a compromise between Republicans and the White House,” Lou Brien said. Analyst at DRW Trading. “But the odds aren’t zero, so the market is discounting the possibility that they’ll be late to prevent a funding problem.”
All of this is happening as the economic outlook is darkening anyway.
TAKING THE AIR OUT
The nation’s chief economist, Kathy Bostjancic, was expecting a recession later this year as the Federal Reserve’s rapid rate hikes to fight inflation raise the cost of borrowing for households and businesses and slow bank lending. All of this is sapping the economy and could push up the unemployment rate, which is now at a historically low 3.5%.
Some economic leaders, such as the Fed, had already forecast last December that the unemployment rate would be about 1 percentage point higher by the end of 2023.
A debt crisis and a default, even if it’s just a portion of the interest payments due each day, would drive it forward, Bostjancic said. In order to make as many payments as possible, the government would have to cut spending as much as possible.
“It has an immediate impact on the cash flow going to individuals or companies,” she said. “That will feed straight into GDP; it reinforces the recessionary scenario.”
In fact, the slight annualized growth rate of US GDP of 1.1% in the first quarter was already seen as a likely peak of the year.
How deep and long-lasting the impact would be, she and others said, would depend heavily on how long any defaults lasted, which in turn would be shaped by how financial markets react — heavily, she and others said.
During the 2008 financial crisis, for example, Congress initially voted against the Treasury Department’s proposed bank bailout fund, but the ensuing record plunge in stock prices and the rise in bond yields quickly changed minds. Lawmakers approved the plan just days later.
Should even that response fail to persuade Congress to quickly lift the debt ceiling, a prolonged breach of the so-called “X-date” could catapult a relatively mild recession – with between 1 and 2 million jobs lost and an unemployment rate of around 5% – in something far more painful, estimated Mark Zandi, chief economist at Moody’s Analytics, in a March report.
In its worst-case scenario of a prolonged breach, where the government is forced to cut spending for an extended period, and consumer and business sentiment are shattered by the political stalemate and resulting financial chaos, unemployment soars over 8% – a loss of 7.5 million and 8 million jobs – and is slow to recover.
With U.S. creditworthiness likely to be permanently impaired, “the economy’s long-term growth prospects are also weakened,” Zandi wrote.
Between those two scenarios, Zandi said the second-hardest economic outcome would be the House Republicans’ plan calling for drastic spending cuts. A recession would come more slowly — likely not before 2024 — but unemployment in that case peaks at nearly 6% and recovers even more slowly than in a longer break.
(Reporting by Ann Saphir and Dan Burns; Editing by Andrea Ricci)
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