Republicans and Democrats are likely to clash next year over the debt ceiling, a fight that could rock financial markets, unnerve consumers and threaten the economy with the specter of a calamitous default.
The looming debt limit battle in Washington could spark the most uncertainty since the 2011 brinksmanship that cost America its perfect AAA credit score and caused chaos on Wall Street, Goldman Sachs warned clients in a note Monday.
“To raise the debt limit next year, bipartisan support will be necessary but hard to achieve,” Goldman Sachs economists wrote in the report.
What’s this all about?
The “debt ceiling” is exactly what it sounds like — the maximum that the federal government is allowed to borrow, after Congress set a level more than a century ago to curtail government borrowing. But when push comes to shove, Congress has in the past raised the debt limit to avoid a default on US debt that economists have warned would be “financial Armageddon.” That’s what lawmakers did in late 2021 following the last standoff over the debt ceiling.
Goldman Sachs notes there have been “more false alarms over the last decade than truly close calls.”
Washington also came together just last week to reach an agreement that averted what would have been a catastrophic rail strike.
But Republicans have signaled a brewing fight over the debt ceiling.
House GOP leader Kevin McCarthy, who is vying to become House Speaker, told CNN before the midterm election that Republicans will demand spending cuts in exchange for lifting the debt ceiling. Republican Senator John Thune of South Dakota told Bloomberg last week the debt ceiling could be a way to push through budget cuts.
‘Another disruptive debate’
That sets the stage for a dangerous fiscal showdown that risks a default on US debt, or at least a close call.
“We remain concerned that the governing dynamic will lead to fiscal fights that could include debt ceiling brinksmanship in mid-2023,” Isaac Boltansky, director of policy research at BTIG, wrote in a note to clients this weekend.
Goldman Sachs noted that the political environment next year will have “echoes of 1995 and 2011” — the two most tense standoffs over the debt limit in recent history. The report said most, though not all, of those standoffs occurred when Republicans controlled at least one chamber of Congress during a Democratic presidency.
“Next year will provide the political and fiscal conditions for another disruptive debate, and razor-thin majorities in both chambers and elevated inflation could further increase uncertainty,” Goldman Sachs wrote in the report. “While hard to predict, it seems unlikely that next year’s debt limit deadline will create quite as much uncertainty as the 2011 experience, but there is a good chance it will come closer than at any point since then.”
Markets and Main Street would be hit
A close call could set off turmoil on Wall Street that causes losses in the retirement accounts and investment portfolios of everyday Americans.
“It seems likely that uncertainty over the debt limit in 2023 could lead to substantial volatility in financial markets,” Goldman Sachs economists wrote, noting that the 2011 standoff helped cause a deep selloff in the US stock market.
Beyond markets, Goldman Sachs said a failure to raise the debt limit in time “would pose greater risk to government spending and ultimately to economic growth than it would to Treasury securities themselves.”
That’s because in order to avoid a default on US debt, the federal government would shift money around to keep paying interest on Treasuries. That would create a massive hole that would need to be filled by delaying a host of other payments — including ones that millions of Americans count on such as paychecks to federal employees, benefits to veterans and Social Security payments.
“A failure to make timely payments would likely hit consumer confidence hard,” Goldman Sachs wrote.
When will a default become a real risk?
The good news is Washington appears to have plenty of time to reach a compromise on the debt ceiling before things get dicey.
Economists at Jefferies said in a recent research report that default risk is unlikely to emerge until “at least” the end of September of next year.
Even though federal debt is likely to reach the statutory limit in the next few weeks, Goldman Sachs said the Treasury Department should be able to borrow as usual until late February or early March. At that point, the government could tap a stockpile of $500 billion in cash to finance the deficit until August.
Beyond that, there is a lot of uncertainty over precisely when default risk would emerge due to a number of moving pieces, including student debt payments and tax revenue.
“Funds could run dry as soon as July and as late as October,” Goldman Sachs said.