Canadian economists are growing increasingly nervous as the United States inches closer to a potential default due to an impasse in debt ceiling talks.
That’s not just because a default, which could happen as soon as the end of this month without a deal, would be catastrophic for the American and global economies. It’s also because the fight over U.S. government spending and debt may have long-term ramifications on investor confidence, those economists told Global News on Friday.
“The bottom line is there’s no good outcome here,” said Michael Gregory, the Bank of Montreal’s deputy chief economist who also oversees U.S. economics at the institution.
“Whether or not there’s a technical default or not, I think that’s almost a moot point.”
The comments were in stark difference from January, when the U.S. first hit the debt ceiling. At that time, economists told Global News there was little reason to worry that a larger crisis couldn’t be averted.
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Growing optimism over a deal being reached this week between Republicans and the Democratic White House came to a screeching halt on Friday, after House Speaker Kevin McCarthy said it’s time to “pause” negotiations due to a standoff over spending cuts.
Talks ultimately resumed Friday evening, though confidence in a weekend agreement appeared to be diminished.
Republicans have made it clear they won’t vote to raise the government’s borrowing limit — currently at US$31 trillion — without those cuts, which Democrats staunchly oppose. A White House official told the Associated Press there are “real differences” between the parties on the budget issues and further “talks will be difficult.”
Looming over the talks is a deadline as soon as June 1 when the U.S. Treasury Department has said it will run out of cash to pay the government’s incurred debt.
That has put urgency not just on negotiators to reach a deal, but also on Congress to then turn that deal into legislation that can be passed — and then signed by President Joe Biden — before the deadline.
Economists say while the June 1 deadline is not set in stone, they’re anxiously watching the rapidly-closing window for all of those hurdles to be cleared.
“I’ll be very concerned if we don’t have a deal in place by the end of the weekend,” Douglas Porter, BMO’s chief economist, said in an interview.
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Wall Street felt the impact of the sudden halt in talks Friday, ending what had been its best week since March —a rally that had been inspired, in part, by signs a deal was within reach.
The S&P 500 went from a gain of 0.3 per cent to a loss of 0.1 per cent, and the Dow Jones Industrial Average went from a gain of 117 points to a loss of about 90 points. Canadian markets were up in contrast, with the S&P/TSX composite index posting a small gain.
A default on U.S. government debt would likely mean a recession for the economy, which has both economists and investors watching the negotiations in Washington closely.
Gregory and other economists say even if a deal isn’t reached, the U.S. Treasury has mechanisms that could be used to avoid a full-on default. But those could also have “ripple effects” in Canada.
One potential solution, prioritization, would see the U.S. pay off debt and interest payments to lenders like China as it seeks to raise money for other programs. While that could stave off default, it could also see missed payments to Social Security recipients, federal workers and others.
Gregory says that would not only lead to a S&P credit downgrade for the U.S. — which happened the last time the debt ceiling debate got close to a default, in 2011 — but “a slate of downgrades across the board” that could have “a legacy impact” on U.S. borrowing costs.
“Over time, that means higher tax rates, which I think ripples across the border,” he said. “The equity volatility ripples across the border, investor uncertainty ripples across the border.
“Something that is awfully bad for the United States will have some degree of badness for Canada.”
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Other economists are less pessimistic, believing that a deal will ultimately be reached — even if it’s at the last minute.
“I think even if we reach a deal with one minute to midnight on the clock for this issue, it will be quickly forgotten,” said Avery Shenfeld of CIBC Economics. “We’ve had these crisis moments before, and the markets usually let bygones be bygones if we get to get past it.
“The real scare is that we don’t reach a deal.”
Shenfeld acknowledges that if a deal isn’t made, the U.S. will likely face a recession that could lead to a “spillover recession” in Canada. Uncertainty in the financial markets — which Friday’s Wall Street dip previewed — would also spread across borders, he added.
“The clock is clearly ticking louder and we’re running out of time,” he said. “But I think there’s still a hope that rationality will prevail.”
Until Friday, the hope in Congress and the White House had been that a breakthrough by this weekend would lead to a potential House vote next week. The Senate, which is currently in recess, is expected to return to vote on a debt limit bill if it emerges.
Biden, who has been in Japan attending the G7 Leaders Summit, has already planned to cut short the rest of his foreign trip and he is expected to return to Washington later Sunday.
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Other factors could also scuttle a deal beyond the standoff over spending cuts.
Some Democrats want Biden to invoke his authority under the 14th amendment to raise the debt ceiling on his own, an idea that raises legal questions and that the president has so far said he is not inclined to consider.
Conservative House Republicans, meanwhile, said late Thursday there should be no further discussions until the Senate takes action on GOP legislation narrowly passed by the House last month.
That bill would raise the debt limit into 2024 in exchange for spending caps and policy changes like work requirements for government aid recipients. Biden has said he would veto that Republican measure and Senate Democrats, who control the chamber, have also rejected it.
Porter, the BMO chief economist, said the political turmoil is driving much of his concern.
“I’m worried that politicians are going to shoot all of us in the foot, but I’m also hopeful that they’ll come to their senses at the last minute, which I believe they will,” he said.