What does the debt ceiling fight do to California’s economy? What experts say

Republicans and Democrats are stuck over how to increase the federal government’s debt limit, and that could mean big economic trouble for California and, for that matter, the nation and world.

California makes up about 15% of the national economy and is poised to become the fourth largest economy in the world.

“Failing to increase the debt ceiling therefore would have the most impact in terms of severe unemployment, deep recession, and sudden stock market declines on the California economy,” said Gokce Soydemir, professor of business economics at California State University, Stanislaus.

“Investors do not like uncertainty, when there is uncertainty present, investors will not invest,” he said.

As a result, “foreign investors would pull their money out of California creating ripple effects on the financial sector of our state which would ultimately affect retirement incomes, social security benefits and other entitlement programs,” Soydemir said.

Mark Schniepp, director of the California Economic Forecast, was more circumspect.

“We don’t really know what would happen to the country, let alone a single state,” he said. “There are many heroic measures the Treasury can pull off to avoid default.”

President Joe Biden, House Speaker Kevin McCarthy, R-Bakersfield, and other top congressional leaders are scheduled to begin talks Tuesday in an effort to find a way to lift or suspend the government debt ceiling.

Treasury Secretary Janet Yellen estimated that unless the limit is raised or suspended “potentially as early as June 1” the United States government could be unable to pay all its bills.

Explaining the debt limit

Here’s a look at what this is all about:

Q: What is the debt ceiling?

A: The federal government is currently authorized to borrow about $31.38 trillion to pay its debts. The government has huge deficits, so unless it can borrow money, it can’t in theory make payrolls, fund its food, nutrition and housing programs and meet other obligations.

Q: Why is there a debt ceiling?

A: The debt ceiling, or limit, was created in 1917 as a way of making it easier to pay for the World War I effort. Before that, Congress would authorize more debt if necessary. The limit has been raised 78 times since 1960, including 20 times since 2001, according to a Brookings Institution study.

The current debt ceiling was approved in December 2021 on a party line vote. It passed after months of political wrangling, and only because Senate Republican Leader Mitch McConnell agreed to allow the increase to pass with a majority vote. Normally it takes 60 votes to move legislation, but this time, it took only the chamber’s 50 Democrats.

Q: What could happen on or around June 1?

A: The country actually reached the debt limit on January 19, but the Treasury is taking what Yellen calls “extraordinary measures” to pay bills. Yellen described those steps, which involve various accounting methods, in a four-page memo in January.

The U.S. has never defaulted on its debt, so it’s not clear exactly what would happen if it did. Chances are that financial markets and lenders would begin to get nervous as the June 1 deadline approaches, triggering all sorts of problems.

Q: Like what?

A: Market prices could tumble. Foreign investors, who like the American markets because of their history of stability, could stay away. Lenders, anticipating higher borrowing costs as the safety and liquidity of government investments is shaken, could raise rates.

Why should you care?

Q: How does this affect me?

A: “It is not at all evident that Californians would feel a lot of pain if the impasse persists,” said Schniepp.

In a worst case scenario, “California could be impacted with closures of some federal offices and perhaps closures or reduced hours or services at national Parks like Death Valley and Yosemite. Because there is a lot of aerospace manufacturing in the state, some payments to government contractors might be delayed. Some program awards may be delayed, postponed, or even canceled,” he said.

Q: Would it suddenly become more expensive to buy homes and cars?.

A: Probably. Interest rates for Treasury securities would likely go up. “If interest rates for Treasuries increase substantially, interest rates across the economy would follow, affecting car loans, credit cards, home mortgages, business investments, and other costs of borrowing and investment,” says the nonpartisan Committee for a Responsible Federal Budget.

Credit could be harder to get. “The balance sheets of banks and other institutions with large holdings of Treasuries would decline as the value of Treasuries dropped, potentially tightening the availability of credit as seen most recently in the Great Recession,” the committee said.

Q: How hard a deadline is June 1?

A: Yellen explained her estimate is “ based on currently available data, as federal receipts and outlays are inherently variable, and the actual date that Treasury exhausts extraordinary measures could be a number of weeks later than these estimates.” in her May 1 letter to McCarthy.

She added, “It is impossible to predict with certainty the exact date when Treasury will be unable to pay the government’s bills,

Q: If the debt ceiling is reached, can’t the Treasury use incoming funds to delay a default?

A: Schniepp explained that the Treasury could delay pension allocations to federal employees and then for postal workers. They can furlough federal employees, shut down national parks or reduce operating hours, and do that for many federal departments. And they can prioritize who gets paid.

“We might really not have to face any kind of default until late this year or early next year if the Treasury is creative enough, and if the House can ‘claw back’ previously appropriated funds that have not been disbursed yet, especially COVID-19 funding that was unused,” he said.

Q: What is Washington doing to avoid this mess?

A: The House passed a Republican plan last month on a party line vote. All of California’s Republicans voted for it and all the Democrats voting voted no. The plan “brings the era of out-of-control spending to an end, saving taxpayers $4.8 billion over the next decade,” said Rep. Kevin Kiley, R-Rocklin.

Democrats want a “clean” debt ceiling that has nothing to do with spending or tax policy. Republicans insist on cuts as part of a package.

Q: What’s next?

A: The House plan is going nowhere in the Democratic-run Senate, so it’s effectively dead. Tuesday’s talks are the first big step in an effort to resolve the crisis. While the two sides appear far apart, Biden has a long history of finding compromise. So does McConnell, though so far he’s not a major player in the talks.