In a bleak warning to Congress, The US Treasury Department has stated that the country could face catastrophic economic consequences if action is not taken to raise the federal debt ceiling. With estimates from the Congressional Budget Office predicting that the US could run out of funds as early as July, the looming debt crisis has sparked widespread fears of a financial meltdown of magnitudes not seen since the Great Depression.
The US hit its $31.4 trillion debt ceiling in January of this year, amid deep political divisions over how to address the issue. Since then, Congress has leaned heavily on emergency measures to keep the government running and stave off default. Without an increase in the borrowing limit, the US could default on debt payments – an event that could “cause irreparable harm to the U.S. economy, the livelihoods of all Americans, and global financial stability” according to Treasury Secretary Janet Yellen. With the Treasury Department already taking “extraordinary measures” to avoid default, a resolution to the issue must be reached soon – or else investors and consumers alike could be forced to bear the burden of a crippling financial crisis.
How Did We Get Here?
The US government has long relied on debt to finance its operations, but years of financial mismanagement and rampant spending have left the country in a precarious position. In recent decades, the federal government has borrowed increasingly large sums of money to fund its activities – money that it can’t pay back without raising the debt limit. This has caused a stalemate between Democrats and Republicans in Congress, as both parties have refused to compromise on the formal budget resolution needed to raise the debt ceiling. With Congress unable to break the partisan gridlock, the US has been pushed ever closer to financial insolvency.
The impasse has been further complicated by the coronavirus pandemic, which added over $6 trillion in debt to the already strained budget. From 1980 to 2019, national debt increased at an average annual rate of 5.6%, but in 2020, debt rose by 18% as relief measures were implemented to support those affected by the economic downturn. The current administration’s hefty stimulus packages have only exacerbated the debt crisis, leading many experts to warn of impending “chaos on the financial markets” and a catastrophic recession if the debt ceiling isn’t properly managed.
More concerning is the US debt-to-GDP-ratio, which now stands at 128%, indicating that debt levels are far beyond what the economy can support. When debt exceeds GDP, it becomes increasingly difficult to repay borrowing costs – an issue with potentially devastating consequences for the US economy. According to the World Bank, a debt-to-GDP ratio above 77% is associated with slower economic growth, with each additional percentage point in the ratio costing the economy 0.017% of GDP growth each year. The US debt-to-GDP ratio has exceeded this threshold since 2009, and with no end to the crisis in sight, the country’s economic prospects look grim.
A Repeat of History
If the current debt ceiling crisis feels familiar, that’s because it is. In 2011, Congress was embroiled in a similar debate over raising the debt ceiling, with Republicans threatening to default on US debt unless President Obama agreed to their budget cuts. The Obama Administration and Congress were initially unable to reach an agreement on increasing the borrowing limit, resulting in a prolonged political standoff that resulted in a downgrading of US credit ratings by both Moody’s and Standard & Poor’s. The downgrades caused shock waves throughout financial markets and sent stocks tumbling, as investors fretted over the US’s financial health. During that same year, the Treasury Department warned that if the debt ceiling wasn’t increased, the US could default on debt payments on August 2, 2011 – the so called “X date” that caused mass panic across Wall Street.
The 2011 crisis eventually came to a close precisely on the X date with the passing of the Budget Control Act, which increased the debt ceiling by $2.4 trillion and implemented caps on federal spending. The legislation was met with criticism from both sides of the aisle, but it managed to avoid disaster and avert a full-blown financial collapse. Although the measure passed narrowly, it did little to address underlying issues and instead only kick-started a cycle of short-term fixes that have been repeated ever since. Congress’s decision to raise the debt ceiling in 2011 was intended to buy time and allow for a more comprehensive agreement. Twelve years later, that agreement still hasn’t materialized and the country remains mired in an endless cycle of brinkmanship. Worse, the decision to raise the debt ceiling in 2011 has set a precedent of sorts, with both parties now expecting the other to acquiesce to their demands.
The US’s current debt crisis is, therefore, one of its own making – a product of decades-long partisan gridlock and short-term fixes that have only delayed the inevitable reckoning. The country’s financial future remains in the balance, and unless Congress is willing to take decisive action, the US could find itself in a much more perilous financial position than it was in 2011. The clock is ticking and the precedent has been set; only time will tell if Congress can learn from its past mistakes and finally break the cycle of brinkmanship. Until then, Americans must brace for a future in which the debt ceiling is perpetually at risk of being breached.
The Prospect of a Default
According to economists, a US default would deal a devastating blow to the world’s largest economy and have far-reaching consequences for the entire global financial system. With the government unable to make debt payments, the value of the US dollar could plummet, leading to an inflationary spiral that would erode the purchasing power of Americans and undermine investor confidence in US Treasury bonds. This, in turn, would have a negative effect on the US’s ability to borrow at low interest rates, as investors would be hesitant to lend money to a government in default. A growing number of economists agree that a collapse of the US dollar would cause it to lose it’s status as the world’s reserve currency, triggering a cascading financial crisis that could spread to other countries and cause a global recession.
The implications for financial markets could be equally dire. With default looming, many economists have warned that global stock markets could plunge as investors rush to dump their riskier assets and seek out safer investments. Defaulting would send a powerful signal to international creditors that the world’s most powerful economy had succumbed to political paralysis – an outcome that could have far-reaching ramifications for countries with large US debt holdings. A massive shift in capital flows could eventually lead to a global financial meltdown, as investors move their money out of the US and into other markets.
The mere prospect of a default in 2021, caused Standard & Poor’s to downgrade US’s gold-standard credit rating, sending stocks tumbling and sharply eroding investor confidence. The loss of confidence in US Treasury bonds could lead to a massive selloff and a surge in bond yields – further weakening the already limping US economy. With the world’s largest economy on the brink of a major financial crisis, market experts have warned that the US’s credibility and credit ratings could take years to recover.
The ripple effects of a default would be felt far beyond Wall Street as ordinary citizens would be forced to bear the brunt of the economic downturn. A US default could have serious implications for unemployment as, without federal funding, many public sector employers would be unable to meet payrolls or pay unemployment benefits. With the government unable to finance job-creation programs, unemployment rates could soar and millions of Americans could find themselves out of work. Inflationary pressures and higher interest rates caused by a US default would likely lead to increased costs for mortgages, credit cards and other consumer debt, while wages and job opportunities would remain depressed. With higher borrowing costs, consumer spending would slow, potentially leading to a prolonged recession.
A Shelter from the Storm
With the US’s reputation as the world’s economic leader at risk of being permanently tarnished amid the unfolding debt crisis, institutional investors and ordinary citizens alike have begun to seek out a safe haven from the storm. Given gold’s long record of maintaining its value over time, many have begun to view it as a critical part of their investment portfolios, one that could help them weather the all-but-certain financial storm that will come in the wake of a US default. As the US government stands on the brink of what could be a financial crisis of unprecedented proportions, those seeking to protect their wealth have begun to turn to the world’s most precious metal as a refuge from the storm.
While demand for gold continues to surge in light of a potential US default, analysts have predicted that gold prices could reach $4,000 per ounce in 2023, more than double its current price. For Americans worried about their financial future, gold stands as one of the few reliable sources of security poised to weather the coming financial storm, according to market experts. As the world watches anxiously to see how this calamitous situation plays out, it’s clear that the enduring appeal of gold could mark the difference between financial security and ruin for many investors.