Throughout the ongoing recovery from the Great Recession, one unsung hero worked tirelessly to propel the economy forward—the creditworthiness of the U.S. government. But that could all change, and fast, if conservatives continue holding the economy hostage to the August 2 debt ceiling deadline.
By helping keep interest rates low, U.S. creditworthiness makes it easier for businesses to invest, eases the financial burden on consumers and homeowners, and makes the immediate federal budget deficit manageable. The real question all Americans should now be asking is not what the risk of default is, but rather how much it will cost us if conservatives squander America’s creditworthiness by not raising the debt ceiling.
No matter what happens with the debt ceiling, America’s creditors will turn out just fine. If we’ve learned anything since the financial collapse of 2008, it’s that in our political system Wall Street always gets theirs—and probably yours, too. But as anyone who has ever had a FICO credit score knows, worse credit means paying higher interest rates. And that, in turn, will mean less money in the pockets of small-business owners, middle-class families, and more taxpayer money paying interest to bond investors. That, in turn, will mean a severe shock to aggregate demand in our economy at a time when it is already operating more than $800 billion below potential due to slack aggregate demand.
“The full faith and credit of the United States” is the mantra ritualistically incanted by investors here and around the world. It is the reason investors worldwide built a global financial system on the foundation of U.S. Treasury assets. Money market funds hold hundreds of billions of dollars’ worth of Treasuries, as do banks, which hold them in reserve as safety against risky loans, and financial traders who post them as collateral for derivatives transactions. Sovereign governments hold hordes of Treasuries to protect themselves from currency speculators. Investors are so willing to put their faith in the United States due to the government’s sterling reputation, painstakingly built over the past half century, because our government bonds offer essentially zero credit risk.
This means a lot to all of us. High demand for Treasuries means interest rates on U.S. government securities are low, and these interest rates provide the baseline on which all other interest rates for business loans, consumer credit, and student financial aid are built. Because our government can borrow low, Americans wanting to launch a new business, buy a home or car, or send their kids to college can borrow low, too. That means a more robust economy and generally higher standards of living.
Interest rates are low now due in part to monetary policy interventions pursued by the Federal Reserve since the start of the Great Recession. But even after the Fed signaled in April intent to withdraw its most recent intervention to buy bonds, known as quantitative easing, or QE2, interest rates on 10-year Treasury bonds fell nearly 0.6 percentage points over the past six months because of the trust that global investors put in the security of a U.S. promise. The reward for creditworthiness is a steady stream of investor capital seeking quality, safe investment assets, which keeps U.S. interest rates low. But if that full faith flounders, we will all pay the price.
Regardless of who has been in charge, policymakers have remained committed to preserving the precious asset of U.S. creditworthiness. But today, as we all know, conservatives are threatening to squander the asset of U.S. creditworthiness in order to protect their wealthy patrons from even one red cent of increased tax revenues to pay for critical public services and investments. This intransigence is the epitome of political hypocrisy: The Republican budget plan, passed on a party line by the House of Representatives in April, will also require raising the debt limit. What will the conservative gamble cost you?
The risk in this high-stakes game of chicken that conservatives are playing with the debt ceiling is already taking a toll on the U.S. economy. In a recent survey from the U.S. Chamber of Commerce, 70 percent of business owners predicted negative consequences from a government default. But by breaching that August 2 deadline, conservatives will be steering us into relatively uncharted economic territory. We know that not raising the debt ceiling will mean an immediate and severe contraction of the U.S. economy, worse than the worst quarter of the Great Recession. What we don’t know is how much extra interest payments Wall Street will demand if U.S. creditworthiness is tarnished, and how long this blight on the United States’ reputation might last.
The last time the United States experienced a “technical default” in 1979—the kind that House Majority Leader Eric Cantor (R-VA) assures us doesn’t really matter—interest rates spiked by some 0.6 percentage points on a “permanent basis.” My colleague, economist Christian E. Weller, estimates that a one-half percentage point increase in the 10-year Treasury rate will raise mortgage rates by 0.66 percentage points. Similar effects will percolate through the rest of the interest rate term structure in our economy, robbing money from the pockets of families and small-business owners. In 1979, however, the economy was surging to the peak of business cycle expansion, whereas today our economy is in a markedly weaker position and the consequences are likely to be even more severe.
Private credit rating agencies, for what they’re worth, are already threatening credit downgrades for the United States should the debt ceiling not be raised. Even if the Treasury prioritizes paying off bondholders before paying retirement and health care benefits to senior citizens, veterans, needy children, and the like, the perceived ungovernability implied is certain to rattle investors’ “full faith” in the United States. Indeed, the damage done by breaching the debt ceiling deadline may not be repairable. If U.S. creditworthiness is so tarnished, investors could grow weary enough to retreat from the U.S. dollar and Treasuries-centered global financial system as University of California, Berkeley, economist Barry Eichengreen argues in his recent book. This would mean permanently higher interest rates and more macroeconomic volatility.
Raising the debt ceiling alone is no panacea for America’s economic woes—especially if any deal withdraws fiscal support from our still-too-fragile economy or undercuts public investments in infrastructure, education, and scientific research and development that make the economy productive and competitive over the long run. Lower interest rates are not sufficient to ensure a robust recovery that delivers jobs and broadly shared prosperity, and we do need to address long-term budget challenges in a sensible fashion. But squandering American creditworthiness is foolish and reckless, and will only make our economic challenges harder to face.
Adam S. Hersh is an Economist at the Center for American Progress.