U.S. debt ceiling: Facts and thoughts

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This post is a guest contribution by Asha Bangalore, vice president and economist at The Northern Trust  Company.

In the April 4, 2011 letter to John Boehner, Speaker of the House of Representatives, Treasury Secretary Geithner indicated that if the debt limit ($14.29 trillion) is not raised by May 16, 2011, the Treasury would undertake extraordinary measures. The letter listed the extraordinary measures as (1) suspending sales of State and Local Government Series (SLGS) Treasury securities; (2) determining that a debt issuance suspension period exists, which would permit the redemption of existing, and the suspension of new, investments of the Civil Service Retirement and Disability Fund (CSRDF); (3) suspending reinvestment of the Government Securities Investment Fund (G Fund); and (4) suspending reinvestment of the Exchange Stabilization Fund (ESF). In further communication on May 2, 2011, Secretary Geithner indicated that these measures would be put in place as of May 16 if Congress has failed to raise the statutory debt limit.

He also noted that due to stronger than expected tax receipts and if the extraordinary measures are enacted to buy time, the Treasury could operate within the current statutory borrowing limit until August 2, 2011. These are facts of the case.

Secretary Geithner’s description of the chain events if appropriate action is not taken is as follows:

We strongly believe a political compromise will be reached and that default will be an imaginary case study. Nevertheless, consider a hypothetical case of Congress failing to raise the debt ceiling. The financial world would be treading in unknown waters essentially. At the present time, financial markets are not spooked, there is relative calm. As the August deadline approaches, uncertainty would translate into significant financial market volatility. The Treasury Department would have to operate on a cash flow basis and may have to prioritize its payments. As noted by Secretary Geithner, several government payments would have to be stopped, limited, or delayed.

The U.S. dollar would suffer a severe setback. More importantly, the “risk-free” status of Treasury securities would be lost and financial market valuations would be affected as a benchmark would no longer be available until another is invented. A default would lead to higher interest rates and further exacerbate the situation.

These are the immediate consequences. More importantly, the medium-term impact should be severe as higher interest costs would hold back the pace of economic growth of an already fragile economy. In the long run, the sterling status of Treasury securities would be tarnished and raise future funding costs as foreign appetite for U.S. debt would be reduced. This in turn would render the challenge of debt management a few notches higher from the present situation.

Source: Asha Bangalore, Northern Trust – Daily Global Commentary, May 13,  2011.

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