Congressional standoff poses new risk to fragile recovery

Fiscal brinkmanship between Democrats and Republicans is threatening to derail the fragile recovery from the coronavirus pandemic and plunge the U.S. back into economic hardship. 

The federal government will run out of funding in less than 10 days unless lawmakers pass a short-term bill to avert a shutdown on Oct. 1. There is broad bipartisan support for a stopgap continuing resolution (CR), but that push is intertwined with a much more polarizing and dangerous battle over the federal debt limit.

The U.S. is on track to default on its debt as soon as next month if Washington does not take action to raise or suspend the federal debt limit.

Previous brief government shutdowns haven’t damaged the broader U.S. economy, and experts are confident the country could withstand another one, even after the pandemic. But the U.S. has never defaulted on its debt, and doing so could cause devastating damage to the recovering economy.

“Shutting the government down would not be an immediate hit to the economy, but a default would be a catastrophic blow to the nascent economic recovery from the COVID-19 pandemic,” wrote Mark Zandi and Bernard Yaros of Moody’s Analytics in a report this week.

Zandi and Yaros estimated that a default would wipe out $15 trillion in household wealth, cut the value of U.S. stocks by a third on whole, cause the U.S. economy to shrink by 4 percent over the following 12 months and push the unemployment rate back up to 9 percent from its August level of 5.2 percent.

“Global financial markets and the economy would be upended, and even if resolved quickly, Americans would pay for this default for generations,” they wrote, warning that borrowing costs for the U.S. would be permanently higher if the country couldn’t stay solvent.

The U.S. can ill afford another economic setback, let alone an unprecedented crisis, with the recovery from the COVID-19 facing significant headwinds and deepening uncertainty.

Employment growth slowed significantly in August as the delta variant surged: 1 million new jobs were created in July followed by just 235,000 last month. Consumer spending rose in August, but mainly due to a surge in online retail offsetting stagnation in the hard-hit restaurant and bar industry.

The Sept. 6 expiration of pandemic jobless benefits left more than 11 million Americans without federal aid but has not appeared to drive a significant increase in hiring yet. And millions of parents have been unable to fully return to work this month as a result of delta-driven school closures.

“When schools are open 60 percent of the time or when they’re always at a threat of being closed because of the delta variant, you might want to wait rather than going ahead and taking a job and starting work only to have to quit three weeks later,” said Federal Reserve Chairman Jerome Powell during a Wednesday press conference.

Powell spoke to reporters moments after Fed officials released projections showing lower levels of employment and growth, and higher levels of inflation, than they expected in June.

The Fed chief added that a default on the national debt would cause “severe damage” to the economy and financial market, adding one unprecedented shock to the recovery from another.

“No one should assume that the Fed or anyone else can protect the markets or the economy in the event of a failure,” he said.

In addition to market turmoil, a default would force the federal government to suspend a wide range of essential services and welfare programs as the economy crumbles.

“In a matter of days, millions of Americans could be strapped for cash. We could see indefinite delays in critical payments. Nearly 50 million seniors could stop receiving Social Security checks for a time,” wrote Treasury Secretary Janet Yellen in a Sunday op-ed for The Wall Street Journal.

“Troops could go unpaid. Millions of families who rely on the monthly child tax credit could see delays. America, in short, would default on its obligations.”

Six of Yellen’s predecessors from both parties also urged congressional leaders to back down in a Wednesday letter, warning that there is “no viable way to manage” the country’s finances if the U.S. defaults.

“This would be true in any circumstances, but it is particularly true now as the timing of borrowing needs are especially uncertain, given the impact of the pandemic and the policy actions enacted by Congress in response,” wrote former Treasury Secretaries Michael Blumenthal, Henry Paulson, Robert Rubin, Larry Summers, Timothy Geithner and Jacob Lew.

Even a prolonged standoff could cause harm across the economy, shake confidence in the recovery and dissuade businesses from investing and hiring until it is settled. An impasse in 2011 over the debt limit did not get resolved until after the U.S. suffered its first credit downgrade in history, and a 2013 showdown resulted in millions more being added to the national debt through higher borrowing costs.

“I have heard both sides referring to this as playing a game of chicken, which is reckless, irresponsible, and their behavior is juvenile,” said Maya MacGuineas, president of the Committee for a Responsible Federal Budget, a nonprofit think tank that promotes fiscal discipline.

“It threatens all of us.”

Despite those stakes, both parties have refused to blink.

Democrats insist Republicans are obligated to help them keep the government open and prevent the U.S. from defaulting on a $28.5 trillion national debt run up by both parties. To up the ante, the House on Tuesday passed a CR that would also suspend the debt ceiling through December 2022, daring Senate Republicans to filibuster it.

But GOP senators have said for months that they will not vote to raise the debt limit, despite doing so three times under former President Trump, even if it’s attached to a CR.

Senate Minority Leader Mitch McConnell (R-Ky.) has argued that Democrats should keep the country solvent on their own by raising the debt ceiling through a $3.5 trillion spending bill they can pass along party lines through budget reconciliation. GOP senators have warned reporters that McConnell isn’t bluffing and they are confident Democrats would take the blame for a crisis.

“On this issue I think Sen. McConnell is going to be like that Missouri mule when it sits down in the mud and refuses to budge,” Sen. John Kennedy (R-La.) said Wednesday.

Kennedy is one of few Senate Republicans willing to vote for a CR-debt ceiling combination, primarily because the bill includes Hurricane Ida relief aid his state desperately needs. But he and his GOP colleagues say there is no way nine other Republicans would join Democrats to provide the 60 votes necessary to break a filibuster over the debt limit.

For now, Wall Street has largely brushed off Washington’s dysfunction over the debt limit. While the stock market plunged on Monday, financial markets have rallied over the course of the week and are largely focused on the Fed’s stimulus, not Congress.

“The markets have been through this before. Sure, if there’s some sort of a precipitous last-minute horrible stare-down contest, you might get a little bit of a reaction from the market, but it’s, you know, I think it’s inured to the fact that this is all nonsense,” said Daniel Alpert, managing partner at New York investment firm Westwood Capital.

Alpert, however, warned that if the debt ceiling fight derails President Biden’s infrastructure agenda, it could cause markets to go “haywire” after months of rallying on the expectation of major federal stimulus. A House vote on the Senate-passed infrastructure bill slated for Monday is becoming less of a certainty as progressives threaten to oppose the measure on the floor.

Wall Street has remained confident lawmakers will strike the necessary agreements, but some Washington veterans are concerned that the severe breakdown in trust between Democrats and Republicans risks tipping the country into disaster.

“The fact that there is as much anger and resentment as there is in our political system, I don’t think anybody should rest 100 percent assured that we’re going to get out of this unscathed until that ceiling is actually increased,” MacGuineas said.