Philly Inquirer: Wharton Profs On Aftermath of US Default
Aftermath of a U.S. government default
Erin E. Arvedlund Published Wednesday, October 16, 2013
If the U.S. government defaults on its debt, what will be the impact in the financial world, and what does it mean for the average citizen?
The answer: There would be a lot of pain to go around.
Perhaps most disturbing would be universal doubt about the creditworthiness of the United States. It would be an unprecedented shattering of the international image of the nation.
Right behind that comes wave after wave of fiscal uncertainty. That doubt will roil the markets, but it goes beyond just bad times for investors.
Uncertainty will play havoc with business owners and middle-class households, who will cut expenses, creating job losses, reducing consumer spending, and rocking an overall economy that has struggled to recover from 2008.
There are key dates approaching, including two additional Thursdays, Oct. 24 and 31.
How much debt is due?
Roughly $120 billion of U.S. debt will mature on or about Thursday. An additional $93 billion is scheduled to mature Oct. 24. The Treasury is expected to roll over the debt – essentially, take on new debt to pay the old debt, which is due to be paid.
The Bipartisan Policy Center recently noted: “One risk is that buyers of government debt will be less likely to participate in Treasury auctions, and for those that continue to participate, [they will] more likely demand higher interest rates, increasing the cost of servicing the existing debt.”
Interest payment due?
The first real test will be the $6 billion in interest payments due Oct. 31.
In the short term, if there is a default, investors might see the stock market – measured by the S&P 500 benchmark index – drop about 27 percentage points, according to the International Monetary Fund. U.S. Treasury bond yields would jump at least 2 percentage points.
Borrowing rates will increase. Already, mortgage rates have spiked since May, and that’s rocking the recovery in household creation, mortgage applications, and construction, basically, long-term debt. That will slow the housing recovery, something the Federal Reserve wants to avoid.
More QE from Fed
The Fed would likely delay any hike in interest rates, attempting to keep short-term borrowing costs as low as possible, until at least the end of 2015 or early 2016, according to professor Susan Wachter of the Wharton School.
Wachter said the Fed could ultimately decide that a debt crisis warranted even more quantitative easing.
China and Japan are the biggest holders of U.S. debt – $3 trillion between them. The debt crisis has only exacerbated the U.S. borrowing situation, and worst case, the Chinese start to sell.
“The U.S. is writing checks that so far no one has started to cash,” said Wharton professor Mauro Guillen. “But what will be the tipping point?”
For now, the U.S. dollar remains the world’s reserve currency, meaning the primary currency in which we and other nations trade and save. But with a debt crisis, the U.S. dollar weakens.
A cut in the U.S. credit rating would further weaken the dollar vs. other currencies.
Spike in gold prices
Only 3 percent of central bank reserves around the world are held in gold, and Mauro estimates that the price of the yellow metal would spike in a sovereign debt crisis. Good for holders of gold, bad for paper currencies.
Cuts in Social Security
Social Security is by far the biggest U.S. government program, under which 95 percent of Americans are supposed to be guaranteed some form of pension as they retire. If Congress can’t pass a budget, the leaders in Washington might start looking for the money in other places – such as Social Security and other entitlement programs.
A higher retirement age, and payouts of only about two-thirds of today’s Social Security benefits, says Wharton professor Olivia Mitchell.
Your Money: Default would crush confidence, squeeze markets, wreak havoc on households, shatter trust.
will exhaust the emergency measures it has used since
May to allow the government to continue borrowing money.
The government is scheduled
to roll over
in maturing debt.
Congressional Budget Office estimates that this is the first date the government could exhaust all of its reserves and begin missing payments.