Debt Ceiling Battle Could 'Spark a Global Recession'

The U.S. is at serious risk of defaulting on its debts and a default "could spark a global recession" if Congress does not agree to raise the federal debt limit in the coming months, an economic expert has warned.

Charles Abraham, U.S. Financial Services Practice Leader at Mazars, a leading audit, tax and advisory firm in the U.S., told Newsweek that a default would lead to higher unemployment, higher interest rates and volatility in the stock market.

The debt limit must be raised so that the U.S. can pay for spending that has already been approved by Congress and the president. The U.S. hit its debt limit of $31.4 trillion last week, leading the Treasury Department to adopt "extraordinary measures" to cover the nation's debt through June.

Speaker of the House Kevin McCarthy has said he won't agree to raise the debt limit— also known as the debt ceiling—without a deal that would see cuts in federal spending.

"We must finally address Washington's irresponsible government spending if we want to put America on a better fiscal path," McCarthy said on Thursday.

President Joe Biden called McCarthy's position "mind-boggling" in a major speech on the economy on Thursday.

"I will not let anyone use the full faith and credit of the United States as a bargaining chip. In the United States of America, we pay our debts," the president said.

The U.S. may not be at risk of defaulting until later this year, with some economists believing the so-called "X date"—the day the government would stop paying its bills—would fall between July and October. Whenever it might happen, a default would have major negative effects.

Risk of a Default 'Too High'

Abraham told Newsweek "there is indeed a real risk of default if the debt limit is not raised, and the U.S. hit the debt limit of $31.4 trillion on January 19, 2023."

He pointed to the fact that Treasury Secretary Janet Yellen "indicated to the Speaker of the House of Representatives the measures taken by the U.S. Treasury to begin a debt issuance suspension period to last through June 5, 2023."

"Both in the January 19 letter and subsequently, in the January 24 letter, she urged Congress to raise (or suspend) the debt ceiling as soon as possible," Abraham said.

"We do believe that the risks that a default would bring are too high for the debt limit not to be raised in short order—in fact Congress has either raised (or revised the definition) of the debt limit nearly 80 separate times since 1960," he said.

Economic Shockwaves

The U.S. has never before defaulted on its debts and Abraham explained that a default would "send several negative shock waves through the U.S. and global economies" and have a major effect on ordinary Americans.

"Tens of millions of American households might not get certain federal benefits, for example Social Security, Medicare and Medicaid, federal aid related to nutrition, veterans, housing, etc., either on time or at all," Abraham warned.

"Government functions such as the postal service and military could be affected if the salaries are not paid," he said.

There could also be a "recession with job cuts."

"Affected households would have less cash on hand to spend into the U.S. economy and a recession would be inevitable under these circumstances," Abraham said. "A recession would be followed by thousands of non-government lost jobs and higher unemployment."

There would also be a rise in interest rates as investors began to lose confidence in the dollar and "rating agencies would likely downgrade the U.S. credit rating and interest rates on Treasury bonds will rise."

"Because consumer and commercial interest rates are directly correlated with T-Bill rates, rates on mortgages, credit cards, and auto loans would also rise. Businesses would also pay higher interest rates on their loans, potentially affecting their cash flows and employee payroll," Abraham said.

Abraham explained that the situation would also cause volatility in the stock market.

"As businesses would have higher borrowing costs, it would limit cash flows and affect balance sheets. Liabilities would increase and therefore, equity would decrease, and stock prices would fall," he said.

A Global Recession

One of the major concerns about a potential U.S. default is the effect it would have on the global economy and the potential for a worldwide recession. Abraham told Newsweek that was a possibility.

"A default would lead to a significant deterioration in the faith and credit of the United States of America and could spark a global recession," he said.

"The U.S. dollar is the world's primary reserve currency, and a default would hurt all countries that invest in treasuries as a 'riskless asset,'" Abraham added.

Ending the Game of 'Chicken'

The debt ceiling fight is almost uniquely American as other developed economies do not have the same system of paying their debts. Abraham told Newsweek it was time for change.

He noted that since 1960 "the U.S. Congress has acted 78 separate times to raise or revise the definition of the debt limit."

"In the past 10 years, there has been a government shut down in October 2013, January 2018, and December 2018 to January 2019," Abraham said. "The political brinkmanship associated with the debt ceiling and the potential for a government shut down always adds volatility to the markets, the economy, and overall risk to the global economy."

"While we do not believe that a change will occur soon—the debt ceiling has been in place since 1917 and prior to that the U.S. Congress was required to approve each debt issuance separately—there must be transparent discussions on how the U.S. can avoid drawn-out negotiations that need to occur at the last minute in order to avoid a shutdown," he said.

"It is time to change how legislators think about the debt ceiling and the long-term impact of playing 'chicken' to achieve sensible solutions to our ever-increasing debt load," Abraham said.