Since it worked so well the last time, Congress is about to flirt once again with the prospect of a U.S. government shutdown, followed by an ignominious and totally unnecessary default on the nation’s debts.
Yes, you’ve heard this before. Yes, it’s tiresome and foolish. But it’s happening again anyway, and financial markets could bear some pain before the whole thing gets settled toward the end of the year.
The U.S. government has reached the legal limit of its ability to borrow money, which happens every few years because a 1939 law requires Congress to approve the aggregate amount of debt the Treasury Department can issue. Treasury is now using “extraordinary measures” to pay everything the government owes, including Social Security payouts, contractor liabilities, federal retiree benefits and interest on government securities. But that can’t go on forever, and by mid- or late October Treasury will reach “X Date,” when it runs short of the money it needs to pay every debt. That would mark the moment of default, if Congress does nothing.
Congress used to approve borrowing-limit increases without much fanfare, but partisan hostility has now made this routine function an episodic showdown in which each party tries to blame the other for a catastrophe that nearly happens. Congress could abolish the debt ceiling, and give Treasury unlimited borrowing authority, eliminating the need for this periodic bickerfest. But Congress doesn’t want to cede its authority to screw things up.
In normalish times, Republicans and Democrats quarrel over who’s responsible for runaway federal borrowing (answer: both parties) and then agree to let the government borrow more before things get out of hand. This is not a normalish time, however. Goldman Sachs argues that complete Democratic control of both the White House and Congress, combined with the Democrats’ ambitious legislative agenda, raises the odds of a breach that could cause real economic damage. Many prior agreements to raise the debt ceiling occurred when control of Congress was split and neither party foresaw any political gain from a prolonged impasse. But Democrats’ narrow majorities now could, ironically, gunk up negotiations even though Democrats want to extend the borrowing limit.
The sinkhole, as usual, is the Senate filibuster that requires 60 votes for a bill to pass. With a bare, 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 this before, so why the trouble this time? Because Democrats plan to use the arcane “reconciliation” process, which requires only a simple majority in the Senate, to pass a huge tax and spending bill enacting many of President Biden’s campaign promises—with zero Republican support.
‘As risky as the 2011 debt limit showdown’
Republicans say that if Dems are going to use the reconciliation process anyway, then they should make a debt-limit extension part of that bill. Which Democrats could. But they don’t want to, for a variety of reasons. It would make tough negotiations on the tax and spending measures even harder, for one. Democrats also want to cast Republicans as the villains (and vice versa) as X Date draws nigh and markets get antsy.
Goldman thinks the brinkmanship could produce material collateral damage. “If neither party blinks, it is conceivable that the Treasury could exhaust its cash balance,” the bank explained in a Sept. 13 research note. “The upcoming debt limit deadline is beginning to look as risky as the 2011 debt limit showdown.”
The 2011 debt-ceiling dispute is notable because it triggered ratings firm Standard & Poor’s to lower the U.S. government credit from the top level, AAA, for the first time in 94 years. S&P cited political dysfunction in Washington and the inability of U.S. lawmakers to address the mounting national debt as reasons for the downgrade. The S&P 500 stock index fell 11% in the days leading up to the downgrade, and another 7% after the move. It took the market six months to regain those losses, even though Congress resolved the debt ceiling impasse.
S&P still holds that lower AA+ rating on U.S. debt, though Moody’s and Fitch still give U.S. debt their highest ratings. Another standoff this year won’t necessarily send stocks reeling as in 2011, and lawmakers may be more sensitive to market moves this time around. But the debt situation is considerably worse than it was in 2011, with the national debt at more than $28 trillion. The faltering recovery from the coronavirus pandemic is another obvious wild card.
Since the government could run short of money right after the fiscal year ends on Sept. 30, a government shutdown may be looming as well. Congress could pass short-term funding measures to keep the doors open, but that gets back to the same political dynamic clouding the debt-ceiling outlook: Republicans see no reason to help Democrats who intend to pass huge new measures Republicans oppose. Government shutdowns don’t normally roil markets, and they tend to end once one party decides it’s losing the messaging battle and bearing too much blame for the government’s inability to function.
If it gets to the point where there’s really not enough money for the government to pay its bills, nobody’s sure what will happen. Treasury could wait until enough tax revenue comes in to pay everything it owes one day at a time, on a delayed basis. It could also prioritize payments, making some in full as they come due but delaying others. There’s no template for this doomsday scenario because doomsday has never arrived before. We may escape X Date once again in 2021, but it’s probably prudent to prepare for a close call.
Rick Newman is the author of four books, including “Rebounders: How Winners Pivot from Setback to Success.” Follow him on Twitter: @rickjnewman. You can also send confidential tips, and click here to get Rick’s stories by email.