How a U.S. Debt Default Can Be Avoided
Author: Greg Valliere
January 10, 2023
THE MARKETS HAVE BELIEVED FOR YEARS that a U.S. debt default is unthinkable, and we have agreed. But this time may be different — at the very least the threat will become a major market concern within months. But there are reasons why an actual default can be avoided:
THE BLAME GAME: If interest rates rise as a crisis approaches, someone will get the blame. And that almost certainly will be militant Republicans, who seem eager to shut down the government. They will be portrayed by Democrats — and moderate Republicans — as willing to crash the economy in exchange for spending cuts that would be very unpopular, especially any tinkering with Social Security or Medicare.
A SPENDING DEAL: Joe Biden has shown in recent months that he’s a good deal-maker, and he could embrace some spending restraint — maybe even a freeze on some outlays — in exchange for raising the debt ceiling, which would avoid a debt default. This would infuriate hard-core House Republicans, but if a crisis is imminent, a deal would be imminent also.
THE LOBBYING CAMPAIGN: As the threat of a debt default approaches this fall, we would expect Wall Street executives, Federal Reserve officials and even Donald Trump to warn the House radicals that they could jeopardize the economy and the markets.
TREASURY MANEUVERS: As in previous debt crises, the Treasury could shift funds from various accounts and stretch out the “drop dead” date for a default. The real “drop dead” date could be in late fall, as Treasury exhausts all of its options.
AND THERE’S AN OBSCURE PROVISION called a “discharge petition” which, legal experts believe, would allow lawmakers to bring a debt ceiling extension directly to the floor of the House, where passage would be likely. In 2002, a discharge petition was successfully used to pass the Bipartisan Campaign Reform Act, known as McCain–Feingold.
MANY OF THESE SCENARIOS could prompt hard-liners to give McCarthy the boot if they’re not happy with him — it’s virtually certain to happen in the next year or two. At some point, McCarthy and Biden and Mitch McConnell will have to work out a deal, which would outrage the hard-liners.
BOTTOM LINE: Chances of a default on U.S. debt has always seemed remote — even in 2011, when credit agencies downgraded U.S. Treasuries before a deal was struck. Another downgrade is possible this summer or fall, and this will keep bond investors on edge. But an actual U.S. debt default — shaking markets here and abroad — is far from likely.
FOR NOW, HERE ARE OUR ODDS: Chances that this will become a significant crisis, 100%. Chances that there will be a last-minute deal, avoiding default: 60%. But if that means there’s a 40% chance of default, the markets definitely have to worry.
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