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Thinking the unthinkable: what if the US defaults?

17 April 2023 George Brown, Economist at Schroders
George Brown, Economist at Schroders

George Brown, Economist at Schroders

While the risk of the US government defaulting on its debt is relatively low, it is higher than it has been in the past. At the very least, investors should buckle up for a bruising battle over the debt ceiling that could inject market volatility and weigh on economic activity.

The US hit its statutory debt limit of $31.4 trillion on 19 January 2023. In response, the Treasury has resorted to accounting sleight-of-hand to ensure it can meet its obligations. But if the debt ceiling is neither raised nor suspended by a yet unknown ‘x-date’ later this year, these workarounds will be exhausted and the US will be unable to borrow more and will technically default on its debt.

It is far from the first time the country has stood on the precipice of default. In fact, the debt ceiling has been modified more than 100 times since World War II. So why should this time be any different? After all, one of the few things that Democrats and Republicans both agree on is the importance of upholding the full faith and credit of the US government.

Each side will no doubt stick to the well-worn playbook of running down the clock to x-date in an effort to make the other blink first. Republicans are seeking deep spending cuts, whereas President Biden wants to raise taxes on corporates and high earners. If past is prologue, the two will engage in partisan brinkmanship until eventually settling on a last-minute compromise.

Such high stakes tactics always run the risk of backfiring as it could lead to an inadvertent default. And the likelihood of such an outcome is more elevated than it has been in previous years. Concessions made by the House Speaker limits the number of legislative solutions, while the ever-increasing political polarisation complicates the task of consensus building.

In this note, we explore how a US default could materialise and what it would mean for markets and the global economy.

Click here to read more...

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