The possibility that the United States Government might default on its debt is becoming very real, as the standoff between President Joe Biden and House Speaker Kevin McCarthy over raising the federal debt limit is causing some anxiety in the market.
And while the United States officially hit its debt limit on Jan 19, prompting the Treasury Department to use accounting manoeuvres known as extraordinary measures to continue paying the government’s obligations and avoid a default, Treasury Secretary Janet L. Yellen has warned lawmakers that the United States could run out of cash by June 1 if the borrowing cap isn’t raised or suspended.
The mere mention of the US Treasury defaulting on its debt is causing panic as such a scenario would have far-reaching consequences, impacting not only the US economy but also the global investment climate and stock markets.
In this article, we delve into the potential repercussions of a US Treasury default, exploring its effects on the stock market and investment climate, and how Rise will provide guidance in navigating these murky waters. So, fasten your seatbelts as we navigate the uncertain terrain of a hypothetical default.
But first, what is the debt limit?
The debt limit is a cap on the total amount of money the United States is authorised to borrow to fund the government and meet its financial obligations. Because the federal government runs budget deficits — meaning it spends more than it brings in through taxes and other revenue — it borrows huge sums of money to pay its bills. Those obligations include funding for social safety net programs, interest on the national debt, and salaries for members of the armed forces.
Approaching the debt ceiling has elicited calls by lawmakers to cut back on government spending. But lifting the debt limit does not authorise any new spending — in fact, it simply allows the United States to spend money on programs that Congress has already authorised.
Why does the United States have a debt limit?
According to the constitution, Congress must authorise government borrowing. In the early 20th century, the debt limit was instituted so that the Treasury would not need to ask Congress for permission each time it had to issue debt to pay bills.
During World War I, Congress passed the Second Liberty Bond Act of 1917 to give the Treasury more flexibility to issue debt and manage federal finances. The debt limit started to take its current shape in 1939 when Congress consolidated different limits set on different types of bonds into a single borrowing cap. At the time, the limit was set to $45 billion.
While the debt limit was created to make the government run more smoothly, many policymakers believe it has become more trouble than it’s worth. In 2021, Ms. Yellen said she supported abolishing the debt limit.
How much debt does the United States have, and how much is the borrowing cap?
The national debt crossed $31 trillion for the first time last year. The borrowing cap is set at $31.381 trillion.
What happens if the debt limit is not raised or suspended?
If the government exhausts its extraordinary measures and runs out of cash, it will be unable to issue new debt. That means it would not have enough money to pay its bills, including interest and other payments it owes to bondholders, military salaries and benefits to retirees.
Economists and Wall Street analysts warn that such a scenario would be economically devastating and could plunge the entire world into a financial crisis.
- Investment Climate in Turmoil
A US Treasury default creates a hostile investment climate filled with uncertainty and risk aversion. Investors, both domestic and international, seek safe-haven assets during times of turmoil. US Treasury bonds have traditionally been considered safety pillars due to their perceived low risk. However, a default shatters this notion, leading investors to question the reliability of US government debt as a safe investment.
When trust is broken, investors look for alternative investment options. Precious metals like gold and silver and cryptocurrencies like Bitcoin often witness increased demand during uncertain times. These alternative investments are viewed as stores of value that can weather the storm of a default. Consequently, their prices surged, reflecting the flight of capital away from traditional markets.
- The Stock Market Roller Coaster Ride
A US Treasury default would undoubtedly trigger significant volatility in the stock market. Investors thrive on stability and predictability, but a default would introduce a high degree of uncertainty, causing panic and anxiety. The US government debt is seen as a risk-free entity with a solid history and track record of financial stability. When the US government fails to pay its debts, it erodes investor confidence, leading to a rapid sell-off of stocks. As a result, stock prices plummet, and market indices experience sharp declines.
- Policy Implications and the Road to Recovery
Following a US Treasury default, policymakers will be forced to undertake swift and decisive action to mitigate the damage and restore investor confidence. Emergency measures, like injecting liquidity into the financial system, implementing fiscal stimulus packages, and introducing regulatory safeguards, might be deployed to stabilise the markets and instil a sense of security.
Rebuilding the investment climate would require concerted efforts to restore trust in US government debt. This could involve implementing fiscal discipline measures, addressing structural issues in the economy, and crafting policies that demonstrate a commitment to debt repayment. These actions would gradually help restore investor confidence and encourage them to reenter the market.
At Rise, our position is clear— to protect your wealth and help you achieve your financial goals. We are optimistic that a deal will be reached soon between the executive and Congress. A deal will bring freshness and relief to the market, which could rally the market. Thus, the best time to INVEST in RISE is now.