Biden has said he is prepared to negotiate over budget issues,but only if those discussions are de-linked from the debt ceiling,which he wants raised unconditionally.

It’s a bizarre situation. The debt at the centre of the stand-off relates to spending that Congress has previously authorised. It’s not related to new spending proposals. Also,the biggest contribution to the rapid increase in the government’s debt in recent years occurred during the Republican’s Trump administration. In those four years,the debt grew from about $US20.5 trillion to $US27.7 trillion.

US Treasury is already using “extraordinary measures” to avoid breaching the existing debt ceiling,using redemptions of investments,deferrals of spending and suspensions of contributions to government pension funds to push out the day of reckoning – the “X-Day” on which it hit the ceiling and was forced to default on at least some of its payments.

That day may have been brought forward from previous forecasts of August/September to,according to Goldman Sachs,as soon as early June by lower-than-expected tax receipts this month.

There have been various forecasts of the damage a default would do,although they are stabs in the dark,given that it is impossible at this stage to predict how Treasury would try to operate after a default – whether they would keep paying the interest and principal on government bonds while savaging spending elsewhere,for instance.

Could Treasuryissue the trillion dollar platinum coin to the Federal Reserve in exchange for newly-printed cash,as some have suggested?

Regardless,if there were a default,the economic effects would inevitably be negative and the financial market effects potentially chaotic.

While there’s regularly been brinkmanship around the debt ceiling,the closest the US got to a default was in 2011.

As that X-date loomed,bond yields spiked,bond market liquidity fell and the sharemarket slumped,falling about 18 per cent during that period. The US lost its AAA credit rating from Standard&Poor’s and the episode is estimated to have cost Treasury about $US1.3 billion in extra borrowing costs that year.

Fed Reserve simulations have estimated that a one-month default during which Treasury maintained all interest payments would increase 10-year Treasury bond yields by 80 basis points,lead to a 30 per cent fall in the sharemarket,a 10 per cent depreciation of the US dollar,a 1.25 per cent increase in the unemployment rate in the first year and 1.7 percentage points in the second.

The Brookings Institute has said that an increase in unemployment of the same magnitude today would cost about two million jobs in 2023 and 2.8 million in 2024.

The international implications of a previously unthinkable default by the US on its debts would also be severe.

In the near time there could be chaos in financial markets and a flight from the US dollar. Longer term it would aid those seeking to undermine the dollar’s status as the world’s reserve currency and would significantly diminish the appeal of lending to,or investing in,the US.

The stakes are therefore high,and not just for the US.

Until quite recently,there was a sense of complacency about the prospect of a default. Similar confrontations have,after all,been resolved at the eleventh hour in the past. The notion of America defaulting on its debts,not because of an incapacity to service them but because of politics,has been almost inconceivable.

In the bond market,however,the yields on one-month Treasury bills have tumbled and those on three-month bills have spiked to create the biggest spread between the securities in more than two decades while the cost of taking out insurance against a default via credit default swaps has surged to its highest since the global financial crisis and more than double that of the cost of insuring against a default by highly leveraged economies like Italy or Greece.

The blowout in the spread between one and three-month bills is a clear signal that bond investors don’t want to be exposed to the potential for a default during the critical period – June,July,August – while the pricing of the credit default swaps says that some investors are taking the potential for a default very seriously.

As they probably should.

The international implications of a previously unthinkable default by the US on its debts would also be severe.

It took 15 attempts for the House leader,Kevin McCarthy,to be confirmed as Speaker because of the wildly disparate nature of congressional Republicans. He was forced to make an array of concessions to secure the post,among them promises that have given unusual leverage to the fiscal conservatives – the “House Freedom Caucus” – in the party room.

How brittle his hold on the House majority is was underscored by the narrowness of the vote on the debt ceiling bill. Four Republicans defected and,had another followed,the bill would have been defeated.

Given not just the Freedom Caucus’ single-minded commitment to reducing debt and deficits (and carving into social and environmental spending),but the sheer weirdness of some in the Trumpist MAGA faction of the party and the political implications for Biden of sacrificing his legislative achievements ahead of a presidential election,the history of last-minute bipartisan support for increases in the debt ceiling might not provide a guide this time.

That,as the market activity confirms,is disturbing,to say the least.

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