How a U.S. Debt Default Can Be Avoided

IT’S A LITTLE TOO EARLY, to start worrying that the U.S. could default on debt payments. The threat has heated up as militant Republicans in the House threaten to oppose a debt ceiling extension, but several factors will come into play before this becomes a genuine crisis by summer.

THE MARKETS HAVE BELIEVED FOR YEARS that a U.S. debt default is unthinkable, and we have agreed. But this time may be different — at the very least the threat will become a major market concern within months. But there are reasons why an actual default can be avoided:

THE BLAME GAME: If interest rates rise as a crisis approaches, someone will get the blame. And that almost certainly will be militant Republicans, who seem eager to shut down the government. They will be portrayed by Democrats — and moderate Republicans — as willing to crash the economy in exchange for spending cuts that would be very unpopular, especially any tinkering with Social Security or Medicare.

A SPENDING DEAL: Joe Biden has shown in recent months that he’s a good deal-maker, and he could embrace some spending restraint — maybe even a freeze on some outlays — in exchange for raising the debt ceiling, which would avoid a debt default. This would infuriate hard-core House Republicans, but if a crisis is imminent, a deal would be imminent also.

THE LOBBYING CAMPAIGN: As the threat of a debt default approaches this fall, we would expect Wall Street executives, Federal Reserve officials and even Donald Trump to warn the House radicals that they could jeopardize the economy and the markets.

TREASURY MANEUVERS: As in previous debt crises, the Treasury could shift funds from various accounts and stretch out the “drop dead” date for a default. The real “drop dead” date could be in late fall, as Treasury exhausts all of its options.

AND THERE’S AN OBSCURE PROVISION called a “discharge petition” which, legal experts believe, would allow lawmakers to bring a debt ceiling extension directly to the floor of the House, where passage would be likely. In 2002, a discharge petition was successfully used to pass the Bipartisan Campaign Reform Act, known as McCain–Feingold.

MANY OF THESE SCENARIOS could prompt hard-liners to give McCarthy the boot if they’re not happy with him — it’s virtually certain to happen in the next year or two. At some point, McCarthy and Biden and Mitch McConnell will have to work out a deal, which would outrage the hard-liners.

BOTTOM LINE: Chances of a default on U.S. debt has always seemed remote — even in 2011, when credit agencies downgraded U.S. Treasuries before a deal was struck. Another downgrade is possible this summer or fall, and this will keep bond investors on edge. But an actual U.S. debt default — shaking markets here and abroad — is far from likely.

FOR NOW, HERE ARE OUR ODDS: Chances that this will become a significant crisis, 100%. Chances that there will be a last-minute deal, avoiding default: 60%. But if that means there’s a 40% chance of default, the markets definitely have to worry.

Related: The Fed’s “7% Solution” Won’t Work This Time

The views expressed in this blog are those of the author and do not necessarily represent the opinions of AGF, its subsidiaries or any of its affiliated companies, funds or investment strategies.

The views expressed in this blog are provided as a general source of information based on information available as of the date of publication and should not be considered as personal investment advice or an offer or solicitation to buy and/or sell securities. Speculation or stated believes about future events, such as market or economic conditions, company or security performance, or other projections represent the beliefs of the author and do not necessarily represent the view of AGF, its subsidiaries or any of its affiliated companies, funds or investment strategies. Every effort has been made to ensure accuracy in these commentaries at the time of publication; however, accuracy cannot be guaranteed. Market conditions may change and AGF accepts no responsibility for individual investment decisions arising from the use of or reliance on the information contained herein. Any financial projections are based on the opinions of the author and should not be considered as a forecast. The forward looking statements and opinions may be affected by changing economic circumstances and are subject to a number of uncertainties that may cause actual results to differ materially from those contemplated in the forward looking statements. The information contained in this commentary is designed to provide you with general information related to the political and economic environment in the United States. It is not intended to be comprehensive investment advice applicable to the circumstances of the individual.

AGF Investments is a group of wholly owned subsidiaries of AGF Management Limited, a Canadian reporting issuer. The subsidiaries included in AGF Investments are AGF Investments Inc. (AGFI), AGF Investments America Inc. (AGFA), AGF Investments LLC (AGFUS) and AGF International Advisors Company Limited (AGFIA). AGFA and AGFUS are registered advisors in the U.S. AGFI is a registered as a portfolio manager across Canadian securities commissions. AGFIA is regulated by the Central Bank of Ireland and registered with the Australian Securities & Investments Commission. The subsidiaries that form AGF Investments manage a variety of mandates comprised of equity, fixed income and balanced assets.