WASHINGTON – Treasury Secretary Janet L. Yellen on Tuesday warned lawmakers of the “catastrophic” consequences if Congress does not raise or suspend the legal debt limit in less than three weeks, saying inaction could lead to a self-inflicted economic recession and financial crisis.
At a Senate Banking Committee hearing where she testified alongside Federal Reserve Chairman Jerome H. Powell, Yellen explained in explicit terms what she expects to happen if Congress does not not process the debt limit until October 18, which the Treasury now believes is when the United States will face a default. In her most public expression of alarm on the matter, she described the stalemate in Congress as a self-inflicted injury of enormous proportions.
His warnings came as the stock market suffered its worst day since May, as investors worried about a cocktail of worries, including the possibility of the government shutting down and defaulting on its debt, persistent inflation, the Delta variant and the Fed’s plans to withdraw some economic support soon. The S&P 500 fell 2% and government bond yields hit their highest level since June, reflecting expectations that the Fed will start slowing its bond purchases as prices rise and the economy will recover.
Congress was struggling to find a way to solve its two immediate problems: financing the government last Thursday and raising the debt ceiling so the United States could continue to borrow money to pay its bills.
After Senate Republicans blocked an emergency spending bill that would have funded the government until early December and lifted the debt ceiling on Monday, Democrats met privately to discuss their options but did not have not found a solution.
In a phone call Monday, Democratic leaders in Congress discussed with President Biden the possibility of bypassing the Republican opposition and unilaterally raising the debt ceiling. They could do so using a fast-track process known as reconciliation that protects tax laws from filibuster – the same maneuver they use to pass their sweeping social policy and climate change bill. But Democrats have publicly resisted this option, which would be complex and time consuming, and most likely require them to vote a series of politically sensitive votes on a range of issues.
Ms Yellen warned that the effects of inaction would be felt throughout the economy: Seniors could see their Social Security payments delayed, soldiers would not know when their paychecks would arrive and interest rates on. credit cards, auto loans and mortgages would increase, resulting in more expensive payments, she said. And she suggested that a default would jeopardize the dollar’s status as an international reserve currency, which Democrats say would be a giveaway for China.
“It would be disastrous for the US economy, for global financial markets and for millions of families and workers whose financial security would be compromised by late payments,” Ms. Yellen said.
The two top U.S. economic policymakers also warned lawmakers on Tuesday that the Delta variant of the coronavirus had slowed the economic recovery, although they expressed optimism that the economy would continue to strengthen.
Their testimony came at a critical time in the recovery. Businesses face labor shortages and consumers face rising prices amid the resurgence of the pandemic. Inflation has been rapid this year, climbing 4.2 percent in the year through July, and is threatening to stay high for some time.
Soaring shipping costs and global factory closures caused by the coronavirus have been a major driver of this year’s price increases. Cars in particular have been in short supply due to a semiconductor shortage, and recent comments from auto industry executives and analyst reports have suggested this may not be resolved quickly. A Bloomberg index that tracks the prices of various commodities – including those related to oil, gas, metals, sugar and coffee – hovered Tuesday at its highest level in a decade. Higher spending on raw materials can lead to higher prices for the things people consume every day.
“Inflation is high and likely will remain so in the months to come before it moderates,” Powell told lawmakers.
Nervousness over China, which has so far been reluctant to bail out the faltering Evergrande Group, a beleaguered residential developer with $ 300 billion in debt, as well as the possibility of persistent inflation in the United States, helped fuel sentiment on Wall Street on Tuesday.
“The nerves for inflation expectations have really started to take hold,” said Fiona Cincotta, senior financial markets analyst at Forex.com. “We’ve seen this before, but they’re back because inflation may not be as transient as central banks initially thought.”
Investors are realizing that Mr. Powell’s Fed is poised to provide less support to markets and the economy in the coming months, both because inflation has risen and because the labor market is recovering. The central bank made it clear last week that it could announce a plan as early as November to reduce the $ 120 billion in government-guaranteed purchases it makes each month.
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These purchases tend to lower longer-term government bond yields and higher stock prices, and their removal can have the opposite effect. Major government bond rates rose sharply on Tuesday, the kind of move that spills over to the economy and makes it more expensive to borrow and operate large companies.
Risks to markets and economic growth are compounded only by political uncertainty emanating from Washington.
Ms Yellen, speaking to the National Association for Business Economics later Tuesday, suggested that a dysfunctional Congress could pose a more serious economic threat than the pandemic.
“A government shutdown would hurt our ability to respond to the pandemic and disrupt normal government operations,” she said. “Painful as it may be, missing the debt limit and honoring our national obligations would be much worse, possibly causing a historic financial collapse and pushing our economy into recession.”
Democrats continued to seek politically acceptable options, with Majority Leader Sen. Chuck Schumer trying to unilaterally waive the 60-vote procedural threshold on Tuesday in favor of a simple majority debt ceiling increase. He presented it as “an issue” for the Senate to address the impending deadline, without demanding Republican votes.
“If Republicans want to shirk their responsibilities – not to vote to pay off the debt they have contracted – so be it,” he told the Senate. “It’s a bad thing, it’s a bad precedent. But this is the exit. It is a way out. “
But such a move required the agreement of all 100 senators, and Sen. Mitch McConnell of Kentucky, the minority leader, blocked Mr. Schumer’s effort.
The House could vote as early as Wednesday on a stand-alone bill raising the debt ceiling, but that would not remove a Republican obstruction.
The deadline for the debt limit was technically reached on August 1, after a two-year suspension that Congress accepted in 2019. Since then, Ms Yellen has taken temporary steps to delay a default.
Cutting it near the deadline could still have economic costs even if Congress narrowly avoids a default. James Lucier of Capital Alpha Partners, a market research firm, said on Tuesday that approaching a potential threshold for new Treasury issues could create liquidity problems in fixed income markets that depend on them for guarantees.
“Either way, the problem has to be fixed,” Lucier said.
Ms Yellen told lawmakers the Treasury Department would likely exhaust the “extraordinary measures” she used to delay a default if Congress did not act by October 18. It was the most precise date offered by the Treasury, which said pandemic relief payments have made it harder than usual to forecast how much cash is available to the government.
“At this point, we would expect the treasury to end up with very limited resources that would quickly run out,” she wrote. “It is not certain that we can continue to meet all of the nation’s commitments after this date.”
For weeks, Ms. Yellen quietly pressured lawmakers to put politics aside and ensure the United States can continue to meet its tax obligations. She has been in contact with Wall Street CEOs and former Treasury Secretaries as she seeks to keep markets calm and find allies who can help her advocate for recalcitrant Republicans, who believe that Democrats must manage the debt limit on their own.
“It is imperative that Congress quickly address the debt limit,” Ms. Yellen said. “The faith and credit of the United States would be compromised, and our country would likely face a financial crisis and economic recession.”
The debt limit has traditionally been approached on a bipartisan basis, but Republicans are refusing to join Democrats in passing legislation to lift the borrowing limit. Republicans argue Democrats have the voices to lift the line themselves and they should. Democrats claim Republicans are playing a dangerous political game.
In a tense exchange with Republican Senator John Kennedy of Louisiana, Ms Yellen said it was possible Democrats could lift the debt limit on their own, but Republicans were shirking their responsibility by refusing to cover. the debts they had helped incur.
“It is very important to recognize that raising the debt ceiling is about paying the bills that Congress has incurred in the past,” Yellen said, noting that deficits had been recorded in the Democratic and Republican administrations. “It’s a shared responsibility.
Mr Kennedy, who was not convinced, said Democrats just wanted to tie Republicans to their big spending plans and a crisis could be avoided by Democrats.
“Easy peasy. Done. Let’s go have a cocktail,” he told Ms. Yellen.