Published On: Mon, May 22nd, 2023
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Debt ceiling default in US would trigger ‘cataclysmic’ recession, experts warn | Personal Finance | Finance

Experts are warning of the dangers posed by the dispute in the US Congress over the country’s $31.4trillion (£25.2trillion) debt default which may lead to a “cataclysmic” recession.

Politicians from across the aisle are working on a deal to borrow more money, which is otherwise known as raising the debt ceiling.

If a deal is not reached by June 1, in less than two weeks, the Government’s debt is set to default.

America has raised the debt ceiling multiple times in the last decade but if it defaults there will be instant ramifications for people across the world.

This is because the US dollar is used as the world’s biggest reserve currency and, therefore, the largest economy.

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Speaking to the BBC, Simon French, chief economist at investment bank Panmure Gordon, warned of the “cataclysmic” consequences of a debt ceiling default.

Mr French explained: “It would make the global financial crisis look like a tea party.”

He added: “It would be pretty cataclysmic.”

In 2007-08, the global economy was impacted by the near collapse of the world’s banking sector which resulted in a recession.

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Economists are sounding the alarm that a similar economic downturn is likely if a default were to be the outcome.

Notably, mortgage rates and prices would go up internationally and there would be even more job losses as a result.

According to Mr French, investors would demand a higher interest rate to purchase Government debt.

The expert said: “Investors will look at this and say, ‘Well if the US can default, what’s stopping the UK defaulting?’”

What is the debt ceiling?

This is the cap on US Government spending which is set by Congress and was recently reached in January 2023.

Since that time, the Treasury has been running down its cash balances and using every method possible to balance the books.

However, Treasury Secretary Janet Yellen has highlighted that “extraordinary measures” will need to be taken to avoid a default on the debt ceiling issue.

If a deal is not reached by Democrats and Republicans, the US Government will be unable to fund its obligations.

This includes paying workers and making Social Security, Medicare and Medicaid payments to benefit claimants.

James Knightly, chief international economist at ING, said: “If a Government shutdown and default look likely, the impact on financial markets, consumers and businesses would be huge at a time when sentiment is already fragile in the wake of recent banking failures.

“Lending conditions, which are already tightening rapidly, could become even more restrictive and a crisis of confidence could quickly envelop the US economy with contagion for the rest of the world.

“Recession risks would be heightened which would push unemployment higher and lead to a more rapid fall in inflation, opening the door to even more aggressive interest rate cuts from the Federal Reserve than we are currently forecasting.”

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