The Cost of Going Off the Cliff

Bloomberg Economics has modeled the effects of a protracted debt ceiling standoff—and they’re horrendous

- David Wilcox

Through wars, recessions, depressions and the pandemic, the US has benefited from Treasury debt being the closest thing in the markets to risk-free. Now that hard-earned reputation may be shoved over the edge of a very tall cliff.

Fights over the government debt ceiling have become routine in Washington throughout the past quarter-century. This one promises to be especially dangerous, partly because of commitments Kevin McCarthy is said to have made to far-right lawmakers seeking deep budget cuts in exchange for their support of his becoming speaker of the House.

Even a short-lived halt in Treasury payments-whether interest owed to bondholders, salaries for federal workers or benefits to Social Security recipients-would elicit a swift and potentially devastating market reaction. Stock prices would plunge and borrowing rates would spike. A full-blown financial crisis cannot be ruled out.

The fallout from a monthslong standoff would be even more dire, with gross domestic product plummeting faster than at any time other than the second quarter of 2020, when much of the economy was shuttered in response to Covid-19. There's also a risk that millions could be thrown out of work. Over the longer term, damaged investor confidence and the resulting increase in US borrowing costs would exact a continuing toll.

On Jan. 19, Treasury Secretary Janet Yellen announced that the country had hit the current debt limit of $31.4 trillion and that she had begun resorting to "extraordinary measures." The use of accounting maneuvers such as deferring contributions to pension funds for civil service employees would allow the Treasury to continue making payments outside the government in full and on the normal schedule for a limited period of time. Yellen told Congress earlier this month that she expects funds to hold up at least through early June. Some analysts say she could keep the dance going until July or even later.