A compromise between the budget proposals being batted around by President Obama and House Speaker John Boehner will, hopefully, be reached before the federal government defaults on any debt.
But what if the August 2 deadline to raise the debt ceiling comes and goes without a compromise? The effects of a government default are usually described in general terms: It’ll be bad, say most economists, really bad. Or in abstract terms: Investors are likely to lose confidence in the U.S. The dollar will lose its “special status.”
But how would the average American be affected if the U.S. government ran out of cash to pay its bills? While it’s only speculation, most economists generally agree about the immediate consequences. Here’s what we ought to expect.
1. Interest rates on Treasury bonds would rise
The first thing to expect is also the most certain outcome. If the government defaults, credit rating agencies would downgrade Treasury bonds, so the U.S. would be forced to pay more to attract investors.
2. Government payments would be suspended
Paychecks for government workers, vendors and state and local governments would likely be withheld or not paid in their normal timely manner, says Vincent Reinhart of the American Enterprise Institute. The Treasury might also decide to prioritize payments. Social Security recipients, who often rely on their check for daily living expenses, would probably be among the first in line. But so would bond holders: The government would likely do everything it could to protect its credit rating.
3. The stock market would drop
The stock market would almost certainly take a big hit. How big? Dean Baker, co-director at the Center of Economic and Policy Research likens that possibility to the worst times of the recession, when the stock market dropped 10 percent in a single day. A memo titled “The Dominoes of Default” circulating around Congress from the think tank Third Way cites estimates that the S&P 500 would lose 6 to 9 percent of its value in a matter of months.
James Horney, vice president for Federal Fiscal Affairs at the Center on Budget Policy Priorities, agrees that the market would see adverse affects, but doubts they would be long-term.
How would retirement accounts be affected? It depends on your allocations, of course, but some economists estimate that all of the gains from 2010 could be wiped out, while Third Way estimates that 401(k)s would lose an average of $8,816.
4. Mortgage rates could increase
As the cost of government borrowing increases, it’s likely to trickle down into the housing sector. “If the U.S. gets downgraded, everybody has to pay higher interest rates,” says Reinhart. Both bond and mortgage rates tend to travel together, and Third Way estimates that American homeowners would, on average, be forced to pay an additional $20,000 over the lifetime of their mortgages.
5. Job losses, possibly by the hundreds of thousands
In the worst months of the Great Recession, the U.S. was losing hundreds of thousands of jobs each month. Those kinds of job losses could recur, says Baker, if a freeze-up of the financial system and an increase in interest rates spooks companies again. Third Way estimated a loss of 650,000 jobs as a result of rising the interest rates alone.
All of these are, of course, speculations. But it’s clear that a government default would have at least some serious consequences for the U.S. economy at a time when the recovery is, at best, stumbling.