Prepare to hate Congress (even more)
As it worked so well last time around, Congress is poised to flirt again with the prospect of a U.S. government shutdown, followed by a ignominious and utterly unnecessary default on the nation’s debts.
Yes, you have heard that before. Yes, it is tiring and stupid. But it’s happening again anyway, and financial markets could suffer before things work out towards the end of the year.
The US government has reached the legal limit on its ability to borrow money, which happens every few years because a 1939 law requires Congress to approve the total amount of debt that the Treasury Department can issue. The Treasury now uses “extraordinary measures” to pay for everything the government owes, including Social Security payments, contractors’ liabilities, federal pensioner benefits, and interest on government securities. But that can’t go on forever, and by the middle or end of October, the Treasury will hit “Date X,” when it runs out of money to pay every debt. This would mark the moment of default, if Congress does nothing.
Congress used to approve increases in borrowing limits quietly, but partisan hostility has now made this routine function an episodic showdown in which each side tries to blame the other for a disaster that almost happened. Congress could scrap the debt ceiling and give the Treasury unlimited borrowing power, eliminating the need for bickering during this time. But Congress does not want to give up its authority to spoil everything.
In normal times, Republicans and Democrats argue over who is responsible for the federal borrowing runaway (answer: both parties) and then agree to let the government borrow more before things get out of hand. This is not a normal period, however. Goldman Sachs argues that complete Democratic control of the White House and Congress, combined with the Democrats’ ambitious legislative agenda, increases the chances of a violation that could cause real economic damage. Many earlier deals to raise the debt ceiling took place when control of Congress was split and neither party anticipated any political gain from a prolonged standoff. But the narrow Democrats’ majorities could now, ironically, derail the negotiations even if the Democrats want to extend the borrowing limit.
The chasm, as usual, is Senate obstruction that requires 60 votes for a bill to pass. With a simple one-vote majority in the Senate, Democrats would need 10 Republicans to join them in a bipartisan vote to extend the borrowing limit. There have been bipartisan votes to do it before, so why the problems this time around? Because Democrats plan to use the obscure “reconciliation” process, which requires only a simple majority in the Senate, to pass a massive tax and spending bill implementing many of the president’s campaign promises. Biden, without any Republican support.
“As risky as the 2011 debt limit showdown”
Republicans say if Democrats use the reconciliation process anyway, then they should include an extension of the debt limit in this bill. What Democrats could. But they don’t want to, for various reasons. This would make difficult negotiations on tax and spending measures even more difficult, on the one hand. Democrats also want to make Republicans the bad guys (and vice versa) as X Date draws near and markets get nervous.
Goldman believes the brink could produce collateral material damage. “If neither party blinks, it is conceivable that the Treasury could use up its cash balance,” the bank said in a September 13 research note. “The next debt limit deadline is starting to look as risky as the 2011 debt limit showdown.”
The 2011 debt ceiling dispute is notable because it prompted rating firm Standard & Poor’s to lower U.S. government credit to the highest level, AAA, for the first time in 94 years. S&P cited political dysfunction in Washington and the inability of US lawmakers to cope with rising national debt as the reasons for the downgrade. The S&P 500 stock index fell 11% in the days leading up to the downgrade, and 7% after the move. It took six months for the market to recoup these losses, even though Congress resolved the impasse on the debt ceiling.
S&P still holds this lower AA + rating on US debt, although Moody’s and Fitch still give US debt their highest ratings. Another stalemate this year won’t necessarily tip stocks like it did in 2011, and lawmakers might be more sensitive to market moves this time around. But the debt situation is considerably worse than it was in 2011, with a national debt of over $ 28 trillion. Another obvious wildcard is the faltering resumption of the coronavirus pandemic.
Since the government could run out of money right after the fiscal year ends on September 30, a government shutdown could also be looming. Congress could adopt short-term funding measures to keep the doors open, but it comes down to the same political dynamic that obscures the debt ceiling outlook: Republicans see no reason to help Democrats who have it. plans to pass huge new measures that Republicans oppose. Government shutdowns do not normally disrupt markets, and they tend to end once one party decides they are losing the battle of the messages and bearing too much blame for the government’s inability to function.
If it gets to the point where there really isn’t enough money for the government to pay its bills, no one knows what will happen. The Treasury could wait for enough tax revenue to arrive to pay everything it owes one day at a time, on a deferred basis. It could also prioritize payments, making some in full as they fall due but delaying others. There is no blueprint for this doomsday scenario because the apocalyptic day has never arrived before. We may escape X Date again in 2021, but it’s probably safe to prepare for a close call.
Rick Newman is the author of four books, including “Rebounders: How Winners Go From Failure To Success.»Follow him on Twitter: @rickjnewman. You can also send confidential advice, and click here to receive Rick’s stories by email.
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