US debt ceiling: Economic ‘catastrophe’ looms ahead of ‘X-date’

The nation is running out of cash, and tense negotiations are currently underway in Congress regarding the US debt ceiling, which currently sits at $US31.4 trillion.

Democrats want it to be raised pronto, while Republicans are pushing for a range of conditions such as spending cuts to be met before agreeing to lift the self-imposed borrowing cap.

If a deal to raise the debt ceiling is not reached immediately, America could default as soon as June 1, according to Treasury Secretary Janet Yellen, who said a default would cause “an economic catastrophe”.

The impact of such a “catastrophe” would be felt across the planet, including in Australia.

Meanwhile, Wall Street has placed the potential default “X-date” – the date it will no longer be able to pay the bills – even earlier, in late May, while a new analysis from The Bipartisan Policy Centre puts the date slightly later, from early June to early August.

“I still don’t think now is the time for panic, but it’s certainly time to start getting concerned because we’re possibly only weeks away from the X-date,” Shai Akabas, director of economic policy at the Bipartisan Policy Centre, told CBS News.

But regardless of when the date occurs, it would cause dire consequences for creditors, contractors and everyday citizens alike, with the government failing to pay its bills including wages, welfare and other payments.

‘Financial Armageddon’

IG Markets analyst Tony Sycamore told news.com.au that if America were to default, the result would be “devastating”.

“The Department of Treasury estimates the X-date to be June 1; however, with special measures, ie short-term fixes and compromise, the X-date might be drawn out until late July or even September,” he explained.

“If negotiations fail to lift the debt ceiling and the X-date is crossed, it would be the first-ever time the US has defaulted on its debt. The fallout would be devastating for markets and for the US.”

Mr Sycamore said a default would spark a “financial Armageddon”.

“The rise in interest rates that would follow a default would make recent central bank rate hikes appear insignificant. Stock markets would crash, wiping out retirees and other investors,” he said.

“The plumbing of the world markets, which rely on the US dollar and US-denominated dollar debt, would buckle and freeze. It would be the equivalent of a financial Armageddon, making the Global Financial Crisis seem like a walk in the park.

“The loss of confidence in the financial superpower that is the US would likely be irreparable.

“Hopefully, lawmakers can find a way to avoid it this time, as they have in the past as the fallout is simply unthinkable.”

How would it all play out?

According to White House economists, a short default would see around half a million jobs disappear, driving the unemployment rate up by 0.3 percentage points. It would also push up interest rates, drop equity prices and send the GDP into free fall.

A longer default would be even more grim, with 8.3 million jobs gone and unemployment soaring by five percentage points higher.

“It’s Congress’s job to do this. If they fail to do it, we will have an economic and financial catastrophe that will be of our own making,” Ms Yellen said recently, telling America’s ABC News that the negotiations between clashing politicians should not occur “with a gun to the head of the American people”.

“We should not get to the point where we need to consider whether the president can go on issuing debt. This would be a constitutional crisis,” Ms Yellen told the ABC.

In a letter issued to Congress last week, Ms Yellen said even if a last-minute deal was struck, it would still cause widespread mayhem.

“We have learned from past debt limit impasses that waiting until the last minute to suspend or increase the debt limit can cause serious harm to business and consumer confidence, raise short-term borrowing costs for taxpayers, and negatively impact the credit rating of the United States,” she wrote.

For now, investors are remaining relatively calm in the face of the growing financial threat, either because the US hasn’t defaulted before despite similar debt ceiling dramas in the past, or because they are unsure of how to handle the situation.

But Gustavo Schwenkler, professor of finance at the Leavey School of Business at Santa Clara University, told CNN that if the crisis was not resolved by the end of May, there will be “a lot more volatility” to come, while JPMorgan Asset Management chief global strategist David Kelly told the network there would be a “major stock market meltdown” if a deal was not struck in time.

And in a statement this week, Josh Bolton, the chief executive of Business Roundtable, an association of chief executive officers of America’s leading companies, said that time was running out to find a solution.

“With the US at risk of defaulting on its obligations as soon as June 1, meaningful, bipartisan discussions on raising the debt ceiling can no longer wait,” Mr Bolten wrote.

“A default would deliver a severe blow to the economy, leading to widespread job losses, decimated retirement savings and higher borrowing costs for families, businesses and the government.”