Washington’s logjam over the government shutdown, and its wrangling
over raising the national debt limit, have already slowed economic
growth, many economists say. But threat of a debt default is grave
enough to coax lawmakers to resolve differences, they hope.
By Mark Trumbull
WASHINGTON — Picture the following chain of events that could play out
as part of the fiscal showdown now engulfing Congress.The stock market
falls by 20 percent or more. The confidence of consumers and
businesses takes a severe dive. The risk of recession rears its head.
Credit-rating firms downgrade the safety ranking of U.S. Treasury
debt. Government borrowing costs jump permanently. And all this
trouble in the United States deals a blow to the rest of the world
That’s how economists paint the potential effects if Congress fails to
agree on raising the nation’s official debt limit — the amount the
U.S. Treasury is allowed to borrow.
Why all the dire implications?
In essence, it’s because in an era of perennial federal deficits, the
ability to borrow is ultimately synonymous with maintaining confidence
in the U.S. government and its currency, the dollar. A debt default by
the giant economy whose bonds have long defined the phrase “risk-free
asset” could throw world financial markets into chaos.
This scenario, while viewed by many as unlikely, has emerged as within
the realm of possibility as Republicans and Democrats vie for leverage
over the nation’s budgetary future.
One sign of worry is that lawmakers allowed a government “shutdown” to
occur as of Oct. 1 — in good measure because many Republicans want to
prevent President Obama’s health-care reform law from taking full
effect next year. It’s not that all federal funds stopped flowing (the
shutdown hasn’t affected Social Security checks, for example), but
pretty much any federal activity not deemed essential ground to a halt
because lawmakers hadn’t authorized spending for the new fiscal year.
All this comes at what is already a challenging moment for the
economy: The pace of growth is weak, the Federal Reserve may soon dial
back its special stimulus efforts, and the law dubbed “Obama care” is
by some accounts creating its own tremors of uncertainty for consumers
“The implications would be very severe” if the debt limit isn’t
raised, says David Berson, chief economist at Nationwide Insurance in
Columbus, Ohio. He calls it “a very, very low probability event.”
Mostly, policy analysts and economists predict that the very dangers
outlined above will be enough to coax politicians toward legislation
that raises the debt limit. But even what one might call a “business
as usual” outcome, with some last-minute maneuvering that averts a
debt-ceiling calamity, carries some economic costs.
Watching politicians step toward the brink of an abyss is unsettling
to investors around the world. U.S. stock prices traded steadily
downward, for example, during the days leading up to the partial
More broadly, perennial gridlock over taxes and spending creates
uncertainty for businesses and consumers. Economists say it’s hard to
tally its precise effect, but they agree it’s negative, and some argue
it’s substantial in scale.
“If not for the logjam in Washington the economy would now be much
closer to full employment,” economist Mark Zandi of Moody’s Analytics
told a recent congressional hearing. He cites an index of “political
uncertainty” that has remained elevated since 2008, and especially
since the passage of Obamacare and the partisan fiscal battles that
followed. Mr. Zandi estimates that heightened uncertainty since 2008
has cost the economy 1.1 million jobs and has boosted the unemployment
rate, currently 7.3 percent, by 0.7 percent.
This political impasse is different from the one back in 2011 that was
patched over in an 11th-hour agreement.
Once again, Republicans who control the House of Representatives are
using a fiscal deadline — in this case the need to fund the government
for a new fiscal year and the need to raise the debt limit — as a
moment to seek leverage against Democrats on legislative priorities.
Little support for ‘defunding’ Obamacare
But this time, the dispute didn’t originate with a clash over the
level of federal spending, or a bid to cut a “grand bargain” designed
to stabilize federal finances for a generation to come. Instead, the
big item for Republicans was opposition to a single Obama initiative,
the 2010 Affordable Care Act (ACA), which this month is at a pivotal
point in its implementation.
The president wants Obamacare to go into effect. Republicans don’t,
and their tea party wing has been viewing fiscal votes as a last-ditch
opportunity to stop the ACA in its tracks, or perhaps at least to
scuttle portions of it.
Mr. Obama appears to hold the high ground politically. The ACA is the
law of the land, and although the public isn’t enamored of the law,
Americans don’t support the Republican goal of “defunding” it,
according to a Christian Science Monitor/TIPP survey.
Obama also has the bully pulpit and has used it to frame his case that
basic congressional responsibilities such as funding the government
and servicing the debt shouldn’t be held hostage to politics.
“One faction of one party, in one house of Congress, in one branch of
government doesn’t get to shut down the entire government just to
refight the results of an election,” he said on Sept. 30. “Congress
needs to keep our government open, needs to pay our bills on time, and
never, ever threaten the full faith and credit of the United States of
Many political analysts, including some on the conservative end of the
spectrum, agree with Obama’s premise that the 2012 election was the
nation’s real opportunity to reconsider the health-care law.
But Republicans can also point to polls showing the public is on their
side. A late September Bloomberg poll found 61 percent of Americans
saying it’s “right to require spending cuts when the debt ceiling is
raised even if it risks default.” Many Republicans say that view syncs
with their efforts to use the debt-ceiling issue as a venue for
pursuing fiscal reforms as well as for taking jabs at Obamacare.
Markets: Above all, don’t default
So how will all this wrangling end?
Quite possibly, Republicans will conclude that the public will put
most of the blame on them for the economic effects of any prolonged
government shutdown or failure to raise the cap on federal borrowing.
Already, surveys including the Monitor/TIPP poll show Republicans
scoring the worst on leadership, heading into the shutdown.
As they seek a face-saving way forward, they might agree to a bargain
that deals simultaneously with the need to fund the government and to
raise the debt limit, while seeking to insert some additional items
(perhaps on entitlement spending or tax reform) that they can point to
as progress toward fiscal responsibility.
“I think it will be solved at the last minute,” says Russell Price,
senior economist at Ameriprise Financial in Minneapolis. “The critical
thing for financial markets is that the United States does not
If that D-word, default, appears to loom close, stock market investors
could start to send an increasingly blunt warning to Washington:
“Could you stop messing with the economy already?”
The last time the U.S. edged near default, when the debt ceiling came
up for review in 2011, the stock market fell by nearly 20 percent even
though Congress in the end allowed all the nation’s bills to be paid
The brinkmanship prompted Standard & Poor’s to knock the U.S. credit
rating down a notch, driving a 600-point drop in the Dow Jones
Industrial Average on a single day.
Economists say the procrastination in 2011 pushed up interest rates on
Treasury borrowing. By one estimate, the resulting higher interest on
those bonds will ultimately cost taxpayers about $19 billion. Consumer
confidence also eroded during that standoff.
This time around, unlike then, the dissonance in Washington doesn’t
coincide with a flare-up of problems in the European economy. But
forecasters widely agree that failure to raise the debt limit on time
— the Treasury has said it will run out of financial running room
around Oct. 17 — would have severe consequences.
One hint: When the U.S. failed to promptly pay interest on some of its
short-term debts for a brief time in 1979 — a kind of accidental but
technical default — economists say it had lasting consequences for
Treasury borrowing costs.
“That has cost us tens of billions of dollars, that one little
mistake,” Zandi said at the recent congressional hearing.
Failure to raise the cap would amount to an immediate and large cut in
federal spending. At present, about $1 in every $5 spent by the
government — whether to pay for programs or for interest on the
national debt — is borrowed. Remove that leeway to borrow, and the
spending cut would add up to more than $500 billion in a year.
Put another way, the cutback would equal about 4 percent of the
nation’s gross domestic product — much bigger than the so-called
sequester spending cuts that took effect earlier this year. That would
be a big shock for an economy that’s been growing at a roughly 2
percent annual pace.
Effect would be felt globally
Investors worldwide, meanwhile, would change their view of U.S.
Treasury bonds, factoring in at least a degree of new doubt about the
safety and reliability of a bedrock investment.
“The financial ramifications could be horrific, and not just in the
U.S. but globally,” says Nariman Behravesh, chief economist of IHS
Global Insight in Lexington, Mass.
As investors push up Treasury interest rates, the cost of borrowing
would ripple upward worldwide, many forecasters say. That would dent
economic growth, perhaps most notably in many emerging-market nations.
The so-called government shutdown is a smaller event, economically,
but damaging nonetheless. In a conference call with reporters, Mr.
Behravesh said the failure to fund discretionary programs knocks about
0.2 percentage points off the nation’s GDP for each week the shutdown
If this seems a weather forecast with all storm clouds, remember:
Forecasters generally say the risks at stake will help steer Congress
away from the debt-limit cliff. And if lawmakers paper over their
divisions, even in a less-than-perfect way, many economists expect
private-sector job growth to gain some traction in the coming year.