Congress is putting US Treasury Secretary Janet Yellen in a tough spot.
Sooner rather than later, unless the Biden administration arrives at a deal with Republican lawmakers, there will come a day when the US is no longer able to pay its debts. When exactly that will happen depends, in part, on the government’s collection of taxes—money to help it stay solvent. But it is notoriously difficult to forecast tax revenue.
As a result, no one is certain when the US will breach its debt ceiling. Yellen thinks it will be as early as June 1, as she wrote in a letter (pdf) to legislators yesterday (May 22). The Bipartisan Policy Center, a think-tank in Washington DC, predicts some date between June and August, with June 2-13 being a particularly fragile time for the Treasury.
What can Janet Yellen do to avoid a debt default?
The next accounting maneuver that Yellen can take, in early June, is one that will have no real long-term impact if the debt ceiling is raised. The Treasury can postpone investment in a pension fund for retired and disabled federal employees; once the debt ceiling crisis has passed, these investments can resume. It’s a way of buying time to buy more time. If the Treasury manages to get the country past June 13, then an influx of quarterly tax revenue on June 14 may allow the US to make it until the end of the month, said Shai Akabas, executive director of BPC’s Economic Policy Program.
But what if Yellen exhausts every possible maneuver, Republicans refuse to budge unless Democrats gut the nation’s services, and president Joe Biden refuses to raise the ceiling unilaterally via the 14th Amendment? At that point, Yellen will have to direct the Treasury Department to prioritize certain debt payments over others. This means the Treasury could choose to pay foreign holders of American debt to avoid a global recession, while cutting social services at home. It could also prioritize in the opposite direction, such thatinvestors overseas lose money even as the Treasury keeps the American social safety net afloat.
A debt default will put Janet Yellen in a precarious position
If the Treasury paid some debts and not others, Yellen would run the risk of neglecting her duties, said Akabas. This could make both Yellen and her department targets for lawsuits from affected parties. Already, a union of government employees has filed a suit against Yellen and Biden, arguing that they have a legal obligation to ignore the debt ceiling.
Evidence is already emerging that the Treasury suspects it will have to engage in debt prioritization and miss payments for the first time in US history. On May 23, the Washington Post cited anonymous sources to report that the Treasury has started asking other federal agencies if it can delay payments to them.
The market may react in even more extreme ways, Akabas noted. Treasury investors will demand higher interest rates or pull out of Treasury securities altogether. (There is also evidence, though, that many investors would flock to Treasurys even more during a default.) Credit rating agencies might begin the process of downgrading the US’s debt rating.
And more fundamentally, the damage done to the economy’s “animal spirits,” to use John Maynard Keynes’s term, would be immense. “We know that the economy is often driven by consumer and business sentiment,” Akabas said. “If that falls off a cliff quickly, it’s hard to get it back.”
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