Tuesday, September 21, 2021

New financial crises are looming

 A funny thing happened on the way to the recovery. The recovering economy has already taken one hit from the Delta variant surge and now there are at least two more looming crises on the horizon.

Battling over the debt ceiling seems sooo 2013, but like deja vu all over again or a bad penny, it’s back. There was a whiff of this impending crisis back in July when I wrote that Congress had to act by August 2 to keep the Treasury Department from being forced to resort to extreme measures. Astute readers will notice that it is now the middle of September.

Photo by Hans Veth on Unsplash

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One major development in the story is that Minority Leader Mitch McConnell said in an interview with Punchbowl News last week that, although he does not want a default, he is leaving it up to Democrats to raise the debt limit.

"It's their obligation. They should step up. It's hard being in the majority. They are the ones who will raise the debt limit," McConnell said, adding, "Do you guys think I'm bluffing?"

McConnell’s statement may be more an acknowledgment of reality than a policy position. Raising the debt ceiling has long been a hot-button issue with Republicans, who almost let the federal government default during the government shutdown of 2013, although they happily suspended the debt ceiling for two years under President TrumpForty-six Republicans signed a letter in August promising not to vote with Democrats to raise the debt ceiling this time.

"So the only issue is, whose responsibility is it to do it? A Democratic president, a Democratic House, a Democratic Senate," McConnell said.

McConnell’s stance that "America must never default" and "the debt ceiling needs to be raised" to avoid a default, but Republicans won’t lift a finger to help is a risky one. On the one hand, it will help to cement the GOP base into place, but on the other hand, if the federal government does default, Republicans are setting themselves up to take the blame.

What would a federal default look like? No one really knows for sure, but the consensus is that it would really, catastrophically bad. That’s probably especially true at a time when the economy is weak after fighting off a global pandemic for 18 months.

In a letter to Congress last week, Treasury Secretary Janet Yellen wrote, "A delay that calls into question the federal government's ability to meet all its obligations would likely cause irreparable damage to the U.S. economy and global financial markets. At a time when American families, communities, and businesses are still suffering from the effects of the ongoing global pandemic, it would be particularly irresponsible to put the full faith and credit of the United States at risk."

Previous brinksmanship over the debt ceiling resulted in Standard and Poors downgrading the federal government’s bond rating in 2011. A default would lead to more downgrades and the effects would ripple throughout the economy. Aside from other economic impacts, the crisis would almost certainly invigorate America’s rivals in seeking to replace the dollar as the world’s reserve currency. That could have lasting implications for the US economy.

Among Republicans, however, cooler heads are unlikely to prevail. Now that the GOP is out of power, its fiscal conservatism has reappeared and with it, a hard line toward increasing the national debt. Some Republicans may also speculate that a financial crisis that reins in the stock market could hurt President Biden and the Democrats.

Since Democrats hold majorities in both the House and Senate, it is likely that they will be able to raise the debt ceiling without Republican help, but there is little room to spare. The measure might have to be included in the upcoming budget resolution that Democrats want to use for their “human infrastructure” bill to avoid a Republican filibuster. The House is set to vote this week on a standalone bill to keep the government operating past the end of the fiscal year on September 30.

At this point, Treasury has not established a default date or a date for when parts of the government will have to be shut down. The guidance issued in July estimated that extreme measures could get the government to some point in October. Per MarketWatch, economists currently rate the risk of default at about 20 percent.

If the debt ceiling is a slow-moving crisis, the other looming financial problem is a newly breaking story. Evergrande, a Chinese real estate development company, is in an even worse position than the federal government. The company is in the process of defaulting on more than $100 million of payments due Thursday.

While this crisis is still new, there is a possibility that the problem of overleveraged Chinese companies could lead to more defaults and that the contagion could spread in a manner similar to the 2008 financial crisis. Due to the interconnected global economy, stock markets beyond China, including the US, are already sinking because of the Evergrande crisis. The question is whether the Chinese government will be able to stop the bleeding and stem the panic.

If the prospect of two financial crises is bad news, there is at least a silver lining. The prospect of financial problems may help to stifle inflationary pressures being felt here in the US. It’s tough to have inflation if worldwide prices and demand are falling due to recession fears.

At this point, no one is predicting a financial or economic calamity, but there are some headwinds and hints of brewing storms. These stories bear watching closely in the coming weeks.

From the Racket

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