The last time the U.S. government went to the brink of defaulting on its debt — in 2011 — the stock market tumbled and there was something close to a panic across the economy before Washington came to its senses and cut a deal.
Much the same scenario is unfolding now, with potentially even more dire consequences, and there are major differences between then and now that make a bad outcome far more likely.
One difference is that the political climate is more vexed. Not only is there greater polarization and intransigence in Congress, but the paper-thin Republican margin, the personalities of key players, and the outside pressures on both parties make compromise harder to reach.
Adding to the hazard, both the government’s fiscal condition and the American economy as a whole are more fragile than the last time such a crisis developed. In 2011, the country was coming out of a recession. This time it appears to be going into one.
“It’s a much dicier economic setting for this to happen,” said Douglas Holtz-Eakin, president of the American Action Forum, a conservative policy and advocacy group in Washington.
And it doesn’t have to come to a full-fledged default for the government and millions of middle-class Americans to suffer serious long-term damage: If foreign governments and financial markets begin to have even the slightest doubt that the U.S. government will pay its bills, they will begin to hedge their bets in ways that push up interest rates and the federal deficit even higher, ultimately costing the American economy and its consumers in the form of higher prices for goods.
That kind of inflation takes decades, not months or years, to bring down.
In the global economy, in which the United States imports much more than it sells abroad, the dollar is known as the world’s reserve currency. That means it’s the currency that all other countries trust to remain rock solid. Being the reserve currency carries huge benefits for the United States. Perhaps most important, it means the U.S. Treasury pays low interest rates when it borrows money to cover deficit spending.
That’s why economists and other experts warn that a default would be catastrophic.
So far, a default has been unthinkable and reason enough to expect a rerun of prior debt-ceiling battles. In 2011 — to date the closest the nation came to defaulting — stocks plunged nearly 20% as the crisis deepened. Thus far, aside from rattling short-term bond markets, investors in U.S. equities have been eerily calm.
“At the moment everyone is just frozen in place. I think we have another week” before stocks turn more volatile, said Chris Rupkey, chief economist at FwdBonds, a financial markets research firm in New York.
President Joe Biden and House Speaker Kevin McCarthy met on Tuesday and planned to meet again, giving people at least a modicum of hope that a deal may still be possible. But neither side has budged from its starting position. The Republican-majority House, on party lines, passed legislation last month that amounts to a nearly 14% cut in federal spending, adding stringent requirements on social programs and unraveling some of Biden’s climate measures.
Biden has insisted that Congress needs to just raise or waive the debt limit, authorizing spending that was already approved by lawmakers.