‘Fiscal Cliff 2.0′ Would Devastate Interest Rates for Decades

Posted in Banking , Debt • October 15, 2013

government spendingWhy does the phrase “debt ceiling” have such an oddly familiar ring to it?

The same group of leaders who decided, following an unsuccessful attempt to agree on the Federal budget, that the best solution would be to just not show up for work the next day is now squabbling over how many trillions of dollars it’s reasonable to owe.

Only this time, it’s not just Veterans and babies who will suffer as a result. Everyone will.

What some might call the latest Congressional pissing contest promises to have deep and lasting consequences on the financial lives of everyday Americans. A report released by the Treasury Department last Wednesday stated that if we were to hit our debt ceiling and default, “Not only might the economic consequences of default be profound, those consequences, including high interest rates, reduced investment, higher debt payments, and slow economic growth, could last for more than a generation.”

But the Treasury’s statements really aren’t all that shocking, because we were faced with the exact same problem in 2011… and again nine months ago. This time around, we’re not dealing with the expiration of a number of tax cuts in conjunction with closing in on the debt ceiling like we were at the end of 2012, which if left unsolved, would have sent us over what was coined the “fiscal cliff.” Even so, we’ll all certainly be headed over a figurative cliff if the government can’t arrive at a solution to reduce our massive national debt and defaults on October 17, 2013.

Keep Reading: 10 Nations that Have Defaulted on Debt

Impact of Debt Ceiling Default on Interest Rates

This fiscal cliff 2.0 would send us to an economic meltdown reminiscent of 2008, when we experienced significant rate changes as a result of the financial crisis; except, the Treasury said, if the U.S. defaults on its debt, we’d be even worse off than we were when that credit bubble burst five years ago.

Debt Ceiling and Interest Rates by the Numbers

 

american debt

debt ceiling

We’ve been mired in near-zero savings rates years now, the trade-off being that mortgage rates are also low. (Bernanke still believes paying nothing on savings accounts will somehow magically result in lots of money for everyone to spend on houses, but that’s a different discussion). Some experts predict that defaulting on the national debt would result in interest rates spiking across the board — good news for struggling savers.

However, in the event we reach our debt ceiling, it’s much more probable that the spike would affect borrowing rates only, while interest rates on deposit accounts would essentially be wiped out.

That’s largely due to the fact that the United States has never defaulted on its debt before. We boast a stellar credit rating, even though it was lowered by Standard and Poor’s in 2011 due to the last debt ceiling debacle. But much like failing to pay your auto or mortgage bills results in a ruined credit score, failing to pay back the country’s debts would have the same affect on its credit rating.

The loss of that superior reputation as a borrower would cause yields on U.S. Treasury bonds to jump (because bond yields increase with risk of default), and subsequently, so would interest rates on loans. Homes, cars, college tuition — all would become extremely costly to finance. In fact, it would not be unlikely for rates to double.

us budget

debt ceiling

With doubled interest rates on auto loans, mortgages, credit cards, etc., there will be very little demand for lending. Combine this with a massive influx in deposits (because markets will be too volatile for most investors to feel comfortable risking their savings) and banks will have no reason to offer higher interest rates  — or any interest all, really — on savings, CDs and other deposit accounts.

Will We Default on the National Debt?

Though we’re not quite down to the 11th hour, which Congress will undoubtedly reach in its debate over how to handle the national debt, markets are already indicating a fear that we won’t reach a resolution in time. The yield on six-month Treasury bills maturing Oct. 31 soared to as high as 0.16 percent on the 4th, from 0.025 percent on Sept. 30.

The Treasury said this might be an early sign the debate over the debt ceiling is impacting financial markets, explaining, “Although the price moves are small and could easily reverse quickly, the fact that yields on Treasury bills that mature at the end of October are higher than bills that mature immediately before or after, might suggest nascent concerns about possible delays in payments on those bills.”

There’s no question failing to raise the debt ceiling and defaulting on the national debt would have a detrimental impact on the economy. Detrimental is probably an understatement.

Of course, the only way this would happen is if our country’s leaders were too stubborn to come to an agreement in time — which sadly, as evidenced by our current government shutdown, is a scenario all too possible.

Photo: DDFic

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