News / USA

US Warns of 'Catastrophic' Effect If It Defaults

A specialist looks at a screen at his post on the floor of the New York Stock Exchange, Oct. 2, 2013.
A specialist looks at a screen at his post on the floor of the New York Stock Exchange, Oct. 2, 2013.
Ken Bredemeier
The U.S. Treasury is warning there could be "catastrophic" economic effects worldwide if Congress does not increase the country's borrowing limit in the coming days so the United States does not default on its financial obligations.

As the U.S. approaches its current $16.7 trillion debt ceiling, the Treasury issued a report Thursday outlining the calamity it says could occur if it runs out of money to pay the country's bills, including interest on money the U.S. has borrowed overseas.

"A default would be unprecedented," Treasury said, "and has the potential to be catastrophic: credit markets could freeze, the value of the dollar could plummet, U.S. interest rates could skyrocket, the negative spillovers could reverberate around the world, and there might be a financial crisis and recession that could echo the events of 2008 or worse."

The country's government is already in the third day of a partial shutdown in a spending impasse between President Barack Obama, a Democrat, and his Republican opponents in Congress. Obama said Congress needs to act quickly to avert a new crisis over the debt ceiling, which the country could reach on October 17.

"You know the United States is the center of the world economy.  So, if we screw up, everybody gets screwed up.  The whole world will have problems, which is why generally nobody has ever thought to actually threaten not to pay our bills.  It would be the height of irresponsibility," he said. 

Obama and Speaker John Boehner, leader of the Republican-controlled House, are locked in a stalemate over government spending priorities.  But Boehner has been telling Republican colleagues in recent days that he will do whatever is necessary to avoid a default, even if he needs votes from Democratic lawmakers to help raise the borrowing limit.

The U.S. and Denmark are the only democratic countries in the world that have imposed a debt ceiling, with other nations choosing to borrow what they need to finance their operations without a prescribed limitation.  A business professor at the University of Michigan, Erik Gordon, said that the U.S. has attempted, without much success, to curb its spending.

"It can't discipline itself without spending money.  It spends money like a drunken sailor.  So Congress imposed a debt ceiling in an attempt to impose some discipline on itself, by saying, you can spend money, but not so much that you breach this ceiling," he said.

The U.S. debt ceiling has been increased more than 100 times in the last century, sometimes rather routinely, other times after extended debate, with lawmakers from the political party that does not control the White House often accusing the country's leader of reckless spending.

The US debt limit:

  • Is the total amount of money the US government can borrow to meet existing legal obligations
  • Obligations include Social Security, Medicare, military salaries, interest on the national debt, tax refunds
  • Raising the debt limit does not authorize new spending commitments
  • Failing to increase the debt limit would cause the government to default on its legal obligations
  • Since 1960, Congress has acted to raise the debt limit 78 times

Source: US Department of Treasury
Obama now says he wants Congress to increase the borrowing limit without negotiating over the country's spending and taxation policies with his Republican opponents. But as a U.S. senator,  Obama voted against an increase in the debt ceiling when a Republican, George W. Bush, was president.

The chief executive of the huge U.S. investment bank Goldman Sachs, Lloyd Blankfein, met with Obama at the White House this week along with other key banking executives. Blankfein said it is imperative that the United States does not default on its financial obligations.

"There's precedent for a government shutdown.  There's no precedent for default.  We're the most important economy in the world.  We're the reserve currency in the world.  Payments have to go out to people - if money doesn't flow in, then money doesn't flow out.  So we really haven't seen this before, and I'm not anxious to be a part of the process that witnesses it," he said.

Michigan business professor Gordon said no one knows what would happen if the U.S. were to run out of money to pay its bills and the debt ceiling is not increased.

"Nobody knows what will happen if it's actually breached, because it's never come to that.  But the fear is that it will destroy the country's status as the safe harbor for investments, that you won't know whether your U.S. government bonds will be paid on time or not. That's virtually unthinkable," Gordon said.

He said even the threat of the U.S. defaulting would have "huge effects worldwide" on investors' confidence in the government's securities.

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