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Economy & Business

Many questions, no concrete answers surround impact of government default

This article first appeared in the St. Louis Beacon: What happens if -- or when – Congress fails to raise the U.S. debt limit? What would a default by the U.S. government mean?

The questions are simple; the answers are not.

Patrick Welch, an economics professor at St. Louis University, cautions about the uncertainty surrounding just the fear of default in addition to what would actually happen if the federal government runs out of borrowing power.

"What you’re hearing is people’s opinion -- and while some of it is based on some knowledge, no one really knows what will happen,’’ Welch said.

While it appears that talks are on between Congress and the White House for another stop-gap agreement to beat the next debt-ceiling deadline – Oct. 17– Welch and other analysts are concerned about the long-term consequences of continually kicking the can down the road.

"With this continuing to happen, it’s having a huge impact on people’s confidence,’’ Welch said. "And one of the big questions is, ‘What are these decision-makers being driven by: the welfare of the country or political agendas?’ ”

The shutdown of the federal government is complicating an already complex situation, and the impact continues to grow, they warn.

"Some people already are getting hurt by this, including people who work for the government who are not getting paid, and some businesses are being impacted. An example would be restaurants near national parks,’’ Welch said. "And no work is being done by the federal employees, which is hurting the public at large.”

Congressional action to pay workers retroactively doesn’t lessen their current pain, he said.

"I can see a lot of people saying, 'Will you really pay me what you owe me? Or will you pay me what you can pay me? How long is it going to take? How much longer will I be without a job?' ’’ he said.

Regarding the debt ceiling, should the government max out its borrowing potential, it could only spend what income continues to come in. If that income were used to pay creditors -- to avoid defaulting -- it would limit the funds available for programs that millions of Americans rely on, Welch said.

On the other hand, a government default would take a major toll on federal government securities that are considered a safe harbor for investors, including small investors.

"Raising the debt ceiling sends essentially two messages: We can spend more. And the second message is that we really are not going to try to repair this problem in the near future,’’ he said.

Navigating through the political rhetoric is understandably difficult for the public, which doesn’t understand the complexities of the debt ceiling, he noted.

"I’m wondering how long this can go on before the public starts saying, ‘Wait a minute. Why are you not trying to fix this by now?’ It’s a policy move that has a potential to have a worse impact on the public at large than just about any policy,’’ he said.

A 'hurt' on the economy?

Steve Hinson, an associate professor of economics at Webster University, also believes that not raising the debt ceiling could have significant ramifications for the economy.

If Congress doesn’t raise the debt ceiling and doesn’t default, there would have to be a significant cut in discretionary spending. Or, Congress could raise taxes, which he added was unlikely to occur in the short run.

"I think it’s even likely we’d probably go back into recession,” Hinson said.

But a default on the country’s debt, he said, could be “catastrophic” for financial markets.

"Debt is used for collateral and all types of transactions,” Hinson said. "So that could cause a seizing up of what they call the repo market, where a firm will, in effect, lend its securities in exchange for cash in the short run. It’s kind of a way of borrowing. Large companies like General Electric use the repo market for cash flow purposes.”

"That makes it difficult for companies to make payroll,” he added. "I remember during the credit crisis, General Electric had to borrow directly from the Fed because they couldn’t borrow cash as they typically were on a short-term basis to make payroll. So it really could be catastrophic in ways I’m still trying to learn and understand as I read this stuff every day.”

The other issue with a default, he said, is that it could prompt lenders to factor in default risk when dealing with federal debt.

"If people start putting in default risk into rates the federal government has to pay on debt -- which right now is practically nothing -- it would go up significantly,” Hinson said. "That would then put a greater burden on the budget because that interest would have to be paid., which would then make it even more difficult, and spending would have to be cut even further so that you could make interest payments. Which then would be a hurt on the economy.”

Or, not as dire as some believe?

A government default is more worrisome than the government shutdown, according to Howard Wall, a former economist with the St. Louis Federal Reserve, who is now chair of the economics department at Lindenwood University. He spoke about the issues on St. Louis Public Radio’s program "St. Louis On The Air.”

Wall noted that the shutdown is the 18th since 1977, though it is the first in recent memory. A shutdown last occurred during the Clinton administration in 1996.

Unless the shutdown drags on, the economic impact would be minimal because furloughed federal workers are traditionally paid after they return to work, he said.

Wall, who is also a research fellow at the Show-Me Institute, said the effects of default would not be as dire as some are predicting because the government has flexibility regarding what it is able to pay with the income it continues to receive.

"It’s no default unless they don’t pay creditors, which are numerous, and that’s now getting to be a bigger part of the budget,'' he said. "You cannot default; you just pay creditors first and not pay other things.’’ 

Not paying creditors would be serious because it would mean that the U.S. would not be able to borrow very easily, he said. And that would also affect the international financial markets, which buy and sell U.S. debt.

"Interest rates for U.S. Treasuries would be higher, and that would be a disaster,’’ he said.

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