Defaulting on the Debt will Affect Markets
By: Tyler Dratch
According to the Secretary of the Treasury Timothy Geithner, the United States has reached its debt ceiling. The debt ceiling is defined as the maximum amount of money the United States government is allowed to borrow from domestic and foreign investors. These investors include individuals investing in U.S. treasury bonds, and entire countries investing in other substantial investments. The debt limit has to be raised from time to time, due to increased government spending and inflation. The United States Congress is the body responsible for raising the debt ceiling, and has done so seventy four times since 1962. Today the debt ceiling stands at $14.29 trillion.
Usually when the debt ceiling is raised, the market feels very little effect. U.S. treasury bonds have always been rating AAA by trusted organizations, and the United States economy has been one of the largest and quickest growing economies across the globe. This debate over the debt ceiling seems to be different though. First, many members of congress are trying to use this procedural debt ceiling vote to decrease government spending. Speaker of the house John Boehner (R-OH) has stated that he will not vote to raise the debt ceiling unless “trillions, not billions” are cut from federal spending. Others in Congress do not want to attach these spending cuts to this form of legislation. This debate has led to a stall in the negotiations. As of May 16th, the government has reached its spending limit, forcing the U.S. treasury to start taking money from federal pension plans to continue funding the government. Reports have stated that the government has only a limit amount of time before it starts defaulting on bonds.
If the United States does reach this upcoming date, U.S. markets are expected to plummet. Since market prices are mainly based on investor confidence, if the United States is no longer able to pay what it owes, stocks will inevitably decrease in value. This stock dive may occur even earlier since investors will start to loose confidence as the country continues to argue over raising the debt ceiling. Basically, if investors do not see that a deal is going to be reached, they will stop buying.
The bond market will also be affected very drastically. If the United States defaults on its debt, most investors will start to sell their U.S. treasury bonds as quickly as possible. This will force the government to raise their interest rates to encourage more investors to continue to buy bonds. Clearly, this will result in riskier U.S. bonds, which have always had an excellent reputation, and will force the United States government to pay even more money on the bonds that they issue.
Finally, there is still not much doubt that a failure to increase the debt ceiling would reap havoc on international markets. While debt crisis in Greece and Portugal did not affect other countries, these nations did not have economies as large as the United States. It is still uncertain what affect a default would have on China, the European Union and other nations.
As debate continues in Washington, it has become more and more clear that time is running out to raise the debt limit. Politically, this decision may require compromise and negotiation. Economically, however, the outlook does not look good. Any signs of uncertainty will shake the entire economy and will hurt investors. As the negotiations play out, most investors are hoping that lawmakers will end this uncertainty and make a deal.
