Two economy watchers say consumers should be paying attention to the current debate in Washington, D.C., about the federal debt ceiling.
One question is whether interest rates will skyrocket if there is a U.S. government default, said Jay Seaton, area president of Apprisen, formerly the Consumer Credit Counseling Service of Northeast Ohio.
“No one really knows, but when you look at the financial markets, what they detest is uncertainty. The potential is there. Who wants to stare over the proverbial abyss?” Seaton said.
Meanwhile, longtime national business researcher Ken Mayland, head of ClearView Economics in Pepper Pike, thinks it is highly unlikely that the United States will default. He defines default as the U.S. not making an interest payment on its debt or not paying off retiring debt.
But to avoid default, the government will have to cut spending — as much as $750 billion — which means lots of people in government and private industry could lose jobs or see pay cuts as government payments are reduced or delayed.
Delaying payments, such as Social Security or to contractors, doesn’t fit Mayland’s definition of default.
“It would be extremely poor judgement to make a point by not paying investors, whether domestic or foreign,” Mayland said.
If there is an actual default, it would be temporary but could cause real financial damage, he said.
Already some money market fund managers have sold off investments in U.S. debt, which affects the value of investments of those who remain in the market and drives up interest rates the country must pay on debt.
Seaton said Monday in an interview that the nation saw the problems in 2008 and “this would be a reminder of how many entities own U.S. debt interests.”
An increase in interest rates would affect debt tied to variable rate language. So a fixed rate on a home mortgage, for instance, would not be affected. But credit cards or any other credit-based accounts that are allowed to be changed with or without notice would be affected.
Seaton acknowledged that there’s not much consumers can do if they are already struggling and the interest rate increases, but said paying anything extra will help.
“If that’s going to pinch you for a time, I would add as much more as you possibly can to the minimum [payment due] during that time,” Seaton said. “Even if my budget is only in my head, I would take a look at my budget and see if I can shift [extra payments] to a higher interest charge, even temporarily.”
Seaton said the government’s situation underscores the importance of having an emergency fund.
“Yes, if you don’t have an emergency fund, it’s a little late, but it’s a reminder of how often emergencies can occur,” he said. “This has been creeping up, but things can come out of nowhere.”
Seaton said while some financial experts suggest having three to six months’ worth of expenses put away, that is often unattainable. He suggests trying for $1,000 in an emergency fund, if possible.
Mayland noted that an actual default would hurt the U.S. dollar’s status as a global reserve currency and lead to a “sale on the dollar because we’re not standing behind our word.”
A default would cause a persistent loss in faith and confidence, he said.
That’s a textbook scenario for an increase in the U.S. inflation rate and higher prices for foreign-made products.
“There’s no reason we have to renege on interest payments,” Mayland said. The United States is projected to make about $220 billion in interest payments this year while taking in a bit under $3 trillion in tax revenue, he said.
If there is a default, normal accounting procedures call for a security to be marked down in value, he said.
“Think of money market and fixed income securities,” Mayland said.
If there is a true default, money market funds that largely invest in short-term U.S. debt could “break a buck,” meaning they lose their $1 per share value, he said.
“That’s a big no-no,” he said. “People have a money market fund because they know it won’t change in value.”
If money market funds “break the buck,” then “you lose confidence in a whole class of instruments. Then it gets ugly,” Mayland said. “That’s a real impact.”
Some mutual funds have been selling off short-term holdings in U.S. debt just in case there is a default, he said. “They can’t afford that amount of assets going to zero.”
The debt ceiling issue is not the same as a default, Mayland said.
The United States is projected to spend about $750 billion more than it takes in this year, he said.
If the debt ceiling is held to what the United States actually receives in revenue, the federal government can still make interest payments and pay for national defense, Social Security, Medicare, general government, veterans benefits and more, he said.
But it would not be able to pay for everything and would need to set priorities by cutting $750 billion in spending, he said.
“So, do you delay paying the plumber or the defense contractor for the F-22s that you just bought?” Mayland said. “That’s another approach.”
The federal government could, for instance, decide to pay just two-thirds of what it owes to everyone with the promise of paying the remaining third at a later date, he said.