US Government Default?! By Les Nemethy, CEO, Euro-Phoenix M&A Advisors, former World Banker

US Government debt has already surpassed the legislated debt ceiling of $31.4 trillion, with the Treasury relying on “extraordinary measures” to stave off default. Janet Jellen, US Secretary of the Treasury, stated that a default could happen as soon as early June, at which time the Government could run out of cash to fund day-to-day operations. Financial markets seem to blithely ignore the risk, figuring that the debt ceiling was raised 29 times over the last 45 years, 2023 will be no exception. But the political divide is greater than ever.

Few people are aware of the damage a default might cause. It would almost certainly unleash a major recession and a big rise in interest rates to compensate for higher risk (and not just on US Government debt). The US Congressional Budget Office recently offered the following impact assessment of a default for the US:

Exhibit 1: Estimated Effects of a Debt Ceiling Standoff, Q3 2023 We are already paying the price of brinkmanship. And the problem could get much worse very quickly.

From the above, one would think that the default is THE big issue that will determine our financial future. I will argue there are much bigger issues.

Bestselling author Stephen Covey once wrote, “We’re often so busy cutting through the undergrowth, we don’t even realize we are in the wrong jungle.”

“Wrong jungle!” is the perfect phrase to describe the tempest surrounding default caused by failure to raise the debt limit. The fact that there is such a massive debt in the first place and that it is increasing so quickly is a much bigger issue. More context on why this is the wrong jungle:

First: de facto the debt ceiling does nothing to curtail debt.

The debt ceiling is an artificial construct. It is legislated by the US Congress and has been reset so many times (as mentioned, 29 times over the last 45 years) so as have no credibility as a limit to indebtedness. It has done little or nothing to keep government debt to go out of control, other than providing an opportunity for horse trading between politicians as a precondition for raising the limit each time.

Second: US Government spending going off the rails is a much bigger issue than the level of debt itself.

Debt levels need to be addressed by reducing spending, not capping debt. The US deficit is currently in the range of 4-5% of GDP, but it is likely to increase to 6-7% due mainly to:
  • Unfunded US Government Liabilities. These now exceed $123 billion, roughly quadruple the level of US national debt—over $900,000 per US household. These reflect the inadequate levels of money being set aside to fund future Medicare, social security etc. These will dictate deficit increases and at some point tax increases.
  • Higher interest costs. With long-term Government debt gradually rolling over and refinancing at ever higher rates, and new debt being raised to fund the deficit, interest costs are increasing rapidly. Interest expense increased from $329 billion to $828 billion for the 12 months ending May 2013 and Dec 2022 respectively. With the compounding effect of interest on interest, interest expense could soon become the single largest expense item on the US budget.
Third, the debt overhang will be with us long after the debt ceiling crisis is over

There is so much drama and media attention surrounding the debt ceiling. In my humble opinion, this detracts attention from the real issues—deficit spending and national debts careening out of control—which make the “wrong jungle” aphorism particularly apt.

A much better solution than the debt ceiling would be the “debt brake” enshrined in the Swiss constitution: Swiss Government receipts and expenditures must be balanced over the long-term. Surpluses must be generated during a boom, to pay for deficits during a recession. It has helped them trim the national debt to below 30% of GDP.

Some final comments

Exhibit 1 above shows the extremely negative impact of a default. Yet the disruption from a full-blown debt crisis could be much greater. The world can ill afford such a crisis. It’s typically the proverbial man-on-the-street and the poor who pay the price. But the “price” will reverberate at multiple levels. For example, if the world economy would decline by 8-10 or more percent, this would also impact our ability to combat global warming as well as potentially affect the balance of power between the US and China. The higher debt levels go, the more systemic risk in our financial system. The stakes of not addressing excess deficit spending and Government debt are simply too high to ignore.

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