WASHINGTON — Treasury Secretary Janet Yellen warned lawmakers on Tuesday of “catastrophic” consequences if Congress failed to raise or suspend the statutory debt limit in less than three weeks, saying inaction could lead to a self-inflicted economic recession and a financial crisis.
At a Senate Banking Committee hearing where she testified alongside the Federal Reserve chair, Jerome Powell, Yellen laid out in explicit terms what she expects to happen if Congress does not deal with the debt limit before Oct. 18, which Treasury now believes is when the United States will actually face default. In her most public expression of alarm about the matter, she described the standoff within Congress as a self-inflicted wound of enormous proportions.
Her warnings came as the stock market suffered its worst day since May, as investors fretted over a cocktail of concerns, including the potential for the government to shut down and default on its debt, persistent inflation, the delta variant and the Fed’s plans to soon withdraw some economic support. The S&P 500 fell 2% and yields on government bonds spiked to their highest level since June, reflecting expectations that the Fed will begin to slow its bond purchases as prices rise and the economy heals.
Congress was scrambling to figure out how to resolve its two immediate problems: funding the government past Thursday and raising the debt limit so the United States can continue borrowing money to pay its bills.
After Senate Republicans on Monday blocked an emergency spending bill that would have funded the government through early December and lifted the debt limit, Democrats huddled privately to discuss their options but have not settled on a solution.
In a phone call Monday, Democratic congressional leaders spoke with President Joe Biden about the possibility of steering around Republican opposition and raising the debt ceiling unilaterally. They could do so by using a fast-track process known as reconciliation that shields fiscal legislation from a filibuster — the same maneuver they are employing to push through their sprawling social policy and climate change bill. But Democrats have publicly resisted that option, which would be complex and time-consuming, and would most likely force them to cast a series of politically tricky votes on an array of issues.
Yellen warned that the effects of inaction would be felt across the economy: Older adults could see their Social Security payments delayed, soldiers would not know when their paychecks were coming and interest rates on credit cards, car loans and mortgages would rise, making payments more costly, she said. And she suggested that a default would jeopardize the dollar’s status as the international reserve currency, which Democrats argue would be a gift to China.
“It would be disastrous for the American economy, for global financial markets, and for millions of families and workers whose financial security would be jeopardized by delayed payments,” Yellen said.
America’s two top economic policymakers also warned lawmakers 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 moment in the recovery. Businesses are facing labor shortages and consumers are coping with rising prices amid a resurgent pandemic. Inflation has been rapid this year, climbing by 4.2% in the year through July, and it threatens to remain high for some time.
Skyrocketing shipping costs and global factory shutdowns caused by the coronavirus have been a major driver of this year’s price increases. Cars in particular have been in limited supply amid a semiconductor shortage, and recent comments from auto industry leaders and analyst reports have suggested that may not be resolved quickly. A Bloomberg index that tracks various commodity prices — including those tied to oil, gas, metals, sugar and coffee — hovered at its highest level in a decade Tuesday. Higher raw material expenses can feed into steeper prices for the things people consume every day.
“Inflation is elevated and will likely remain so in coming months before moderating,” Powell told lawmakers.
Jitters about China, which has so far been reluctant to bail out the teetering Evergrande Group, a beleaguered residential developer with $300 billion in debt, along with the possibility of persistent inflation in the United States, helped tank sentiment on Wall Street on Tuesday.
“Nerves, as far as inflation expectations, have really started to take over,” said Fiona Cincotta, a senior financial markets analyst at Forex.com. “We’ve seen this before, but they’re back because inflation might not be as transitory as central banks initially thought.”
Investors are waking up to the reality that Powell’s Fed is poised to provide less support to markets and the economy in the coming months, both because inflation has moved up and because the labor market is healing. The central bank signaled clearly last week that it could as soon as November announce a plan to pare back the $120 billion in government-backed security purchases it has been making each month.
Those purchases tend to push yields on longer-run government bonds lower and stock prices higher — and their removal can have the opposite effect. Key government bond rates rose sharply Tuesday, the sort of move that ripples through the economy and makes it more expensive for large companies to borrow and operate.
The risks to markets and economic growth are only compounded by political uncertainty emanating from Washington.
Yellen, speaking later Tuesday to the National Association for Business Economics, suggested a dysfunctional Congress could pose a graver economic threat than the pandemic.
“A government shutdown would impair our ability to respond to the pandemic and disrupt normal government operations,” she said. “As painful as this would be, failing to address the debt limit and defaulting on our national obligations would be far worse — likely provoking a historical financial collapse and causing our economy to fall into recession.”
Democrats continued searching for politically palatable options, with Sen. Chuck Schumer, the majority leader, trying Tuesday to unilaterally waive the procedural 60-vote threshold to pass a debt ceiling increase with a simple majority. He framed it as “a way out” for the Senate to address the looming deadline, without requiring Republican votes.
“If Republicans want to abscond from their responsibilities — not vote to pay the debt they incurred — so be it,” he declared on the Senate floor. “That’s a bad thing, that’s a bad precedent. But this is the way out. It is a way out.”
But such a maneuver required agreement from all 100 senators, and Sen. Mitch McConnell of Kentucky, the minority leader, blocked Schumer’s effort.
The House could vote as early as Wednesday on a stand-alone bill raising the debt limit, but that would fail to clear a Republican filibuster.
The debt limit deadline was technically reached on Aug. 1, after a two-year suspension that Congress agreed to in 2019. Since then, Yellen has been taking temporary steps to delay a default.
Cutting it close to the deadline could still have economic costs even if Congress narrowly avoids a default. James Lucier of Capital Alpha Partners, a markets research firm, said Tuesday that approaching a potential cutoff of new Treasury issuances could create liquidity problems in the fixed-income markets that depend on them for collateral.
“One way or another, the problem needs to be fixed,” Lucier said.
Yellen told lawmakers that the Treasury Department was likely to exhaust the “extraordinary measures” she has been employing to delay a default if Congress has not acted by Oct. 18. It was the most specific date that has been offered by the Treasury, which has said that pandemic relief payments have made it harder than usual to predict how much cash the government has available.
“At that point, we expect Treasury would be left with very limited resources that would be depleted quickly,” she wrote. “It is uncertain whether we could continue to meet all the nation’s commitments after that date.”
For weeks, Yellen has been quietly pressing lawmakers to put politics aside and ensure that the United States can continue to meet its fiscal obligations. She has been in touch with Wall Street chief executives and former Treasury secretaries as she looks to keep markets calm and find allies who can help her make the case to recalcitrant Republicans, who believe that Democrats must deal with the debt limit on their own.
“It is imperative that Congress swiftly addresses the debt limit,” Yellen said. “The full faith and credit of the United States would be impaired, and our country would likely face a financial crisis and economic recession.”
The debt limit is traditionally addressed on a bipartisan basis, but Republicans are refusing to join Democrats in passing legislation to lift the borrowing cap. Republicans argue that Democrats have the votes to lift the debt limit on their own and that they should do so. Democrats argue that Republicans are playing a dangerous political game.
In a tense exchange with Sen. John Kennedy, R-La., Yellen said it was possible that Democrats could lift the debt limit on their own but that Republicans were shirking their responsibility by refusing to cover debts they helped incur.
“It is very important to recognize that raising the debt ceiling is about paying bills that Congress has incurred in the past,” Yellen said, noting that deficits had been run under Democratic and Republican administrations. “It’s a shared responsibility.”
Kennedy, who was unconvinced, said that Democrats just wanted to tie Republicans to their big spending plans and that a crisis could be averted by Democrats.
“Easy, peasy. Finished. Let’s go have a cocktail,” he told Yellen.