United States may soon run out of money unless the limit on federal borrowing is raised or suspended

Autor: Article based upon analysis from Reuters Breakingviews | Link: Debt crisis is a scary white swan for US economy
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Sometime between June and July, the United States will run out of money. That will be the first major test for President Joe Biden since he announced his candidacy for a second term in the White House today.

If Democrats and Republicans cannot agree to raise the ceiling on government borrowing, the country could face an unprecedented and catastrophic default.

History suggests lawmakers will reach a last-minute agreement, but even a close call could rattle fragile markets. In the wake of bank failures and heightened volatility, the last thing Biden – and the U.S. financial system – need is an entirely avoidable crisis.

Investors tend to worry about „black swans,” unpredictable, rare and catastrophic events as defined by author Nassim Nicholas Taleb.

Washington is currently threatened by a different animal. The standoff over the debt ceiling is a white swan, or a completely predictable, very common event that has the potential to be as catastrophic as its darker sibling.

Since 1960, Congress has fought nearly 80 times over the debt ceiling, which determines how much money the Treasury can borrow to pay its bills.

The current ceiling is $31.4 trillion, and lawmakers are nearing the next deadline. Moody’s Analytics believes the so-called „X deadline” could occur in late July.

However, weaker-than-expected tax revenues increase the likelihood that the government will run out of money as early as early June, the firm added.

Reaching that deadline without a congressional solution would result in a catastrophic default. The Treasury would then be unable to issue debt to fund the nation’s needs.

That, in turn, would force the government to make drastic spending cuts to eliminate its $350 billion budget deficit. Those cuts would shrink the economy by 4% in just one year and destroy about 7 million jobs, raising the unemployment rate to 8% from 3.5% today, according to Moody’s.

The stock market would crash on the news, losing a fifth of its value and eroding household wealth by $10 trillion. Even if lawmakers quickly restore government borrowing, the CRA estimates the economy would still lose 900,000 jobs a decade after default.

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In addition, the Federal Reserve is unlikely to be able to accept U.S. government bonds as collateral, making it nearly impossible for the central bank to inject liquidity into the financial system.

For this reason, Congress has historically raised or suspended the debt ceiling in every dispute over the national debt. And while markets are betting on another solution, that confidence is beginning to fade.

The cost of hedging against a sovereign default, as measured by credit default swaps on Treasury bonds, has risen to its highest level in more than a decade.

The yield on three-month Treasury notes hit a 22-year high Thursday, a sign that investors are shunning bonds that would be hit by even a short default.

Recent history shows that even if Congress succeeds in reaching an agreement before the „X date,” there are dangers The U.S. government nearly ran into payment difficulties in 2011 because intense partisanship prevented an agreement until two days before the Treasury deadline.

Uncertainty over the timing of the agreement led to the most volatile week for financial markets since the 2008 financial crisis, with the Chicago Board Options Exchange’s VIX index, a measure of market volatility, tripling.

Corporate borrowing costs jumped as investors fled to safer assets. And for the first time in history, a credit rating agency – S&P Global – downgraded U.S. government debt.

A similar, though less damaging, episode followed two years later. Without those two debt problems, the U.S. economy would have been $180 billion larger in 2015, according to Moody’s. The unemployment rate would have been 0.7% lower.

Repeating the mistakes of 2011 and 2013 would exacerbate the very risks that led to last month’s bank failures. As investors lose confidence in the risk-free reputation of government bonds, they will demand higher yields, as evidenced by the jump in yields on short-term Treasury bills.