By Kirk Kardashian, July 2011
Published Jul 08, 2011
If the United States defaults on the federal government’s debt, the consequences would be catastrophic. That was the central message in Tuck professor Matt Slaughter’s testimony before the House Democratic Steering and Policy Committee on July 7.
The hearing, organized by Democratic Leader Nancy Pelosi, came in the midst of heated negotiations between Republican and Democratic lawmakers and the Obama Administration on proposed spending cuts and tax reforms to pay for an increase on the $14-trillion debt ceiling. The White House has warned that a deal must be reached by July 22 in order to write and pass the necessary legislation before the August 2 deadline.
If that deadline is not met, said Slaughter, associate dean of the MBA program at Tuck and Signal Companies’ Professor of Management, “America is tempting a financial crisis of unknowable proportions.”
A default would be most devastating to the U.S. and global capital markets, Slaughter said, because of the role U.S. Treasury bonds play as the world’s risk-free asset. If institutional investors start believing Treasury bonds are a riskier investment than before, it could mean higher interest rates and tighter credit supplies. But, added Slaughter, an expert in economics and the politics of globalization who spent two years on the Council of Economic Advisers under George W. Bush, “no one really knows what a default would do to Treasurys and the world more generally.”
The trickle-down effects of a spike in interest rates could have an impact on every player in the economy, from students borrowing for college to businesses taking loans for property, plant, and equipment investments, Slaughter said.
American jobs and wages could also suffer. “Default risks further harming scores of millions of American workers and their families who have been facing years, and in many cases decades, of no labor-market improvement,” said Slaughter.
Federal Reserve Chairman Ben Bernanke recently told the Senate that a default would be a “recovery-ending event.” Slaughter’s testimony echoed that belief and added some context, stating that it will take several years of economic growth to add the jobs that were lost during the Great Recession, but that forecast is predicated on “no major financial or economic crises recurring.” A default, he said, could trigger a new recession, more job losses, and prolonged wage stagnation.
“America’s fiscal challenges are grave,” Slaughter told the committee. “As such, America should be doing everything in its power not to cast doubt on the pledge to honor our debts.”