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How much would debt default damage US? History offers clues.

In negotiating a last-minute deal before the United States runs out of money to pay all its bills, the White House and Republicans in Congress are playing with fire of uncertain heat.

The Treasury says that, perhaps as early as June 1, it can no longer assure that all federal bills will be paid, unless Congress raises the nation’s debt limit to allow resumed borrowing.

Why We Wrote This

Debt limit talks in Washington carry high stakes for the economy. Even going to the brink of default can harm investor confidence. Yet past cases of mini default are reminders that financial armageddon isn’t guaranteed.

Republicans, who control the House of Representatives, are threatening to oppose a debt limit increase if Democrats don’t agree to spending cuts.

The U.S. has at times reneged on promises, such as breaking the dollar off the gold standard in the Great Depression.​

Still, history – and each passing day now – shows that even approaching a default on debts can take a toll on financial market confidence. “We have already seen Treasury’s borrowing costs increase substantially for securities maturing in early June,” Secretary Janet Yellen wrote in a letter Monday to House Speaker Kevin McCarthy.

In the mini default of 1979, when technical glitches forced the Treasury to delay payments to bondholders for a few weeks, interest rates on U.S. debt rose 0.6 percentage points and didn’t go back down once the problem was fixed.

In negotiating a last-minute deal before the United States runs out of money to pay all its bills, the White House and Republicans in Congress are playing with fire of uncertain heat.

Every day without a deal takes a toll on financial market confidence, as a possible debt default draws near. The Treasury says that, perhaps as early as June 1, it can no longer assure that all federal bills will be paid, unless Congress raises the nation’s debt limit to allow resumed borrowing.

In one scenario, the politicians reach agreement in time and the damage to America’s reputation remains minimal. In another scenario, talks fail and investors worldwide unload U.S. Treasury bills and notes in a fire sale as the government fails to make all its obligated payments. Stock markets plunge, interest rates surge, and the chaos triggers an international recession.

Why We Wrote This

Debt limit talks in Washington carry high stakes for the economy. Even going to the brink of default can harm investor confidence. Yet past cases of mini default are reminders that financial armageddon isn’t guaranteed.

There is a third scenario, where talks fail but investors don’t panic, at least at first, and market declines goad politicians to reach a deal before causing an economic armageddon.

Uncertainty remains so high because the U.S. has never before gone over the brink in quite this way. But previous episodes when the nation has reneged on its financial commitments suggest that all these scenarios are plausible. If President Joe Biden and Republicans fail to reach a deal before the U.S. Treasury runs out of cash, economic armageddon is not a foregone conclusion.

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