U.S. Default Prospect Hurts Economy in the Meantime

Even if the markets remain calm, higher borrowing costs drain public resources. An analysis by the Government Accountability Office estimated that the 2011 debt limit standoff raised the Treasury’s borrowing costs by $1.3 billion in the 2011 fiscal year alone. Back then, the federal debt was about 95 percent of the nation’s gross domestic product. Now it’s 120 percent, which means servicing the debt could become a lot more expensive.

“It eventually will crowd out resources that can be spent on other high-priority government investments,” said Rachel Snyderman, a senior associate director of the Bipartisan Policy Center, a Washington think tank. “That’s where we see the costs of brinkmanship.”

Interrupting the smooth functioning of federal institutions has already created a headache for state and local governments. Many issue bonds using a U.S. Treasury mechanism known as the “Slugs window,” which closed on May 2 and will not reopen until the debt limit is increased. Public entities that raise money frequently that way now have to wait, which could hold up large infrastructure projects if the process drags on longer.

There are also more subtle effects that could outlast the current confrontation. The United States has the lowest borrowing costs in the world because governments and other institutions prefer to hold their wealth in dollars and Treasury bonds, the one financial instrument thought to carry no risk of default. Over time, those reserves have started to shift into other currencies — which could, eventually, make another country the favored harbor for large reserves of cash.

“If you are a central banker, and you’re watching this, and this is a kind of recurring drama, you may say that ‘we love our dollars, but maybe it’s time to start holding more euros,’” said Marcus Noland, executive vice president at the Peterson Institute for International Economics. “The way I would describe that ‘Perils of Pauline,’ short-of-default scenario is that it just gives an extra push to that process.”

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