Practical analysis for investment professionals
29 October 2015

Debt Ceiling Default: No Big Deal?

Posted In: Economics

In the United States, debt ceiling negotiations – or the lack thereof – have become a biennial ritual over the last several years, replete with hand-wringing prognostications of economic doom and despairing cris de coeur over a “broken” political system.

The recurring drama has had a number of ramifications, increased market volatility and a reduction in the US credit rating among them. The latest round of negotiations, however, has been seemingly less acrimonious and less damaging to the markets compared to its 2011 and 2013 predecessors. Indeed, indications are that far from the brinkmanship of the last two debt ceiling debacles, everything could come off without the usual dose of index-rattling chaos. The House of Representatives approved a compromise bill with bipartisan support, and the Senate is expected to soon follow suit, leaving plenty of time to raise the debt ceiling before the 3 November deadline. If passed, the bill would render the debt ceiling issue moot until 2017, when the next president and Congress would have to take it up.

Which isn’t to say the accord is a done deal. Republican presidential candidate Senator Rand Paul of Kentucky has pledged to filibuster the compromise, and there have been other rumblings of discontent. So there is still ample opportunity for things to fall apart.

Which raises the question: What happens if the debt ceiling is not increased and the United States defaults on its debt? We posed similar questions to our readership during the last debt ceiling imbroglio, and the results were somewhat inconclusive. That is, back in the 2013 polls, most respondents thought that in the event of a default the markets would rebound after a short-term sell-off, but that a default would nevertheless do long-term damage to the global economy. Perhaps more clarity will have emerged the third time around?

As straightforward as it may seem, the question is a complicated one, with considerable subtext embedded within it. Put another way: How critical is the full faith and credit of the United States to the domestic and global economy?

According to more than half of CFA Institute Financial NewsBrief respondents, the answer is not very much.

What will happen if the United States fails to raise its debt ceiling and defaults?
What will be the consequence if the US fails to raise its debt ceiling and defaults?

A majority (53%) of the 550 respondents said that a default would essentially be no big deal.

The remaining 47% begged to differ, of course. About 14% expected the downside of default to be felt mostly in the United States, with 2% predicting a US depression and 12% a US recession. Another 33% anticipate more widespread reverberations, with 20% betting on a global recession, and 13% expecting the worst, a worldwide economic collapse.

The results show an interesting evolution in thinking. Back in 2013, more than two thirds of respondents said a default would do lasting harm to the global economy. Two years later, a clear majority doesn’t think it would be that problematic.

What accounts for this change? Why do our readers believe that a US default would not be so destabilizing? Have they concluded that the markets have already factored in Washington dysfunction and now see it as part of the cost of doing business, like paying rent? Could it be debt-ceiling fatigue? Has the issue just sucked up too much oxygen over the last several years that all people can do is shrug?

Or maybe the formal solvency of the US government isn’t as vital to the global economy as the country’s actual ability to pay its debts. The United States no doubt has the financial wherewithal to appease its creditors, even if it may lack the political will to do so.

We’d certainly like to hear your thoughts in the comments section below.

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All posts are the opinion of the author. As such, they should not be construed as investment advice, nor do the opinions expressed necessarily reflect the views of CFA Institute or the author’s employer.

About the Author(s)
Paul McCaffrey

Paul McCaffrey is the editor of Enterprising Investor at CFA Institute. Previously, he served as an editor at the H.W. Wilson Company. His writing has appeared in Financial Planning and DailyFinance, among other publications. He holds a BA in English from Vassar College and an MA in journalism from the City University of New York (CUNY) Graduate School of Journalism.

3 thoughts on “Debt Ceiling Default: No Big Deal?”

  1. Dylan says:

    There’s just generally way less noise around the issue than in recent times. Less ‘hype’ around the potential implications naturally ‘calms’ expectations.

  2. Ray says:

    The federal government raises so much tax revenue that it could cover interest and maturities on existing debt for a long time before the debt ceiling affected the government’s ability to pay its obligations. So, I suspect a majority of CFA Charterholders responded this way because of the thin connection between a failure to raise the debt ceiling and the subsequent default on any debt. If the question were merely about default and ignored the debt ceiling, I suspect more Charterholders would have thought it more important.

  3. Courtney says:

    The level of reserves that other countries hold in US debt seems, to me anyway, to be why there wouldn’t be any immediate shock to our economy if we don’t reach an agreement. Of course, it’s harder to make that assumption about the long-term. At any rate, I can’t imagine any destabalizing issue arising from our debt-holders trying to convert. Especially in the event of a default.

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