As the United States approached a debt ceiling problem at the beginning of 2023, the possibility of a U.S. default on its debt became a significant cause of concern.
The Treasury Department hit its debt ceiling of $31.4 trillion in January 2023. After months of deliberation, Congress voted in June 2023 to suspend the ceiling until January 2025.
The total national debt as of June 2023 is more than $32 trillion.
When Will the U.S. Default on its Debt?
So far, America has never defaulted on its debt. But recent debt ceiling challenges have raised the risk of such an event.
A U.S. debt default occurs when the government fails to meet its debt obligations.
Here are two scenarios that the United States could default:
Stopping the Increase or Suspension of the Debt Ceiling
When Congress delays deciding whether to raise or suspend the U.S. debt ceiling, companies and consumers often lose faith in the economy.
This indecisiveness often leads to higher interest rates, uncertainty in the financial markets, and a downgrade of the U.S. credit rating.
Any danger of default might prompt credit rating companies to downgrade the creditworthiness of the United States, which would affect the stock market. For instance, the Dow Jones Industrial Average plunged 140 points the moment Standard & Poor's (S&P) downgraded the creditworthiness of the U.S. from AAA (extremely strong) to AA+ (very strong).
Failure to Pay Interest on Treasury Bonds
People trust that Treasury bills, notes, and bonds are safe investments. The government uses these instruments to borrow money, comprising some of the U.S. debt. Most investors believe that the U.S. government would fully back up Treasurys.
But if the U.S. stops paying the interest on Treasurys, their value on the secondary market would drop. Investors would have to sell them at a considerable discount.
In addition, the federal government could no longer sell Treasurys at auctions, curtailing its ability to raise money from investors to pay its bills.
U.S. Debt Ceiling History
On January 19, 2023, the United States reached its debt limit again when the national debt exceeded $31.4 trillion.
Congress raised the debt ceiling by $2.5 trillion in December 2021.
Until Congress raises the cap on how much the government can owe, the Treasury Department has to use "extraordinary measures" to pay the government's bills. However, these steps are unsustainable. If the government continues to use these measures, the risk of a U.S. default is quite high.
The last time the country hit its debt ceiling was on Aug. 1, 2021. The limit at that time was $28.4 trillion.
If Congress did not permit the U.S. debt ceiling to be raised or suspended, the Treasury Department couldn't issue more Treasury bonds. These bonds generate money to pay the nation's bills. The government would have to choose what to pay: federal employee salaries, Social Security, or the interest on the national debt. Non-payment of this interest would result in a U.S. default on its debt.
What Would Happen if the U.S. Defaults On Debt?
A U.S. default would severely impact both the domestic and global economy. Some of the key consequences include:
Economic Instability: A default might cause interest rates to rise, resulting in higher borrowing costs for households and companies. This, in turn, could trigger inflation, raising the price of products and services for everyone.
Stock Market Turmoil: The stock market would greatly suffer if investors lose confidence in the country's ability to pay its debt. Investors will shy away from the reliability of U.S. investments, leading to market volatility and potential declines.
Impact on Social Programs: Millions of Americans rely on Social Security and Medicare. The stability of these social programs could be at risk due to funding constraints resulting from a U.S. default on debt.
The default would also negatively impact small businesses depending on federal funding and people relying on military wages.
Business Closures and Job Losses: A default could cause uncertainty in the business landscape, leading to potential closures and layoffs, further impacting the economy.
All these consequences are bound to decrease consumer spending drastically and inevitably trigger a recession.
Note: The economies of other countries that have defaulted (or barely avoided default) on their debt have suffered greatly. Greece avoided bankruptcy in 2009 and 2010 after receiving assistance from the European Union. Greece is still working to repay its debt.
Iceland, however, defaulted. This event led to the collapse of its banking system.
How A U.S. Default Can Affect the Housing Market
The effect of a U.S. debt default would be catastrophic because almost every investor around the world holds U.S. Treasurys.
The primary effect is that all of the institutions that hold U.S. Treasurys would lose faith in the American government. This would worsen as the default continued. As holders sold their Treasurys, the value of existing debt would plummet. As a result, the value of the dollar itself would also fall. This would make other currencies more attractive, and U.S. debt holders would buy these other countries' debt as a safe haven. The most likely beneficiary would be eurobonds.
Should the U.S. default on its debt, interest rates would spike, drastically increasing the cost of loans such as mortgages. Home and commercial property sales would dive, almost certainly pushing the economy into a recession.
How a U.S. Default Can Be Avoided
The simplest method for Congress to avoid a sudden default on its obligations is to increase or suspend the debt ceiling.
The best way, however, is for the United States to generate more revenue to help pay its debt. This revenue may be sourced from higher taxes and spending cuts.
The U.S. implemented a series of tax increases and defense spending cuts in the 1990s. These measures, coupled with an economic boom, saw four years of budget surpluses for the first time in 40 years. The surplus funds contributed to the reduction of the national debt and the avoidance of a default.
In A Nutshell
A U.S. default on its debt in 2023 could bring the country into a recession, impacting employment, real estate, businesses, social programs, and the financial market, among others.
The United States has yet to default on its debt. Congress must take great pains to avoid such an occurrence. It must make prompt decisions to raise or suspend the debt ceiling or explore revenue-increasing measures to avert a U.S. default and protect the nation's reputation as a reliable borrower.
