ECONOMY

Defaulting on U.S. Debt is Just Plain Stupid

Congress is close to devastating America's shaky economy, its reputation around the world--and its small business owners.
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The U.S. is just 10 days away from defaulting on the national debt, currently worth about $16.7 trillion. And with both Democrats and Republicans stuck on their political positions and unwilling to budge, it's like watching a car wreck in slow motion.

Over the weekend Congressional Republicans and Speaker John Boehner announced they would not raise the debt ceiling or end the government shutdown, now in its sixth day, until President Obama agrees to budget changes that would defund the Affordable Care Act. Obama has rejected that idea, noting that his signature health care act passed both houses of Congress and was approved in a Supreme Court ruling in 2012.

The internecine brinksmanship is bringing the U.S. government closer to a potentially cataclysmic economic event that could cause a financial market meltdown similar to what occurred in 2008 or much worse.

Debt Default Is Destructive

"No country in the world has ever voluntarily defaulted for political reasons, and the notion that the U.S. should do so when we are the foundational economy for the global economy is particularly irresponsible," says Robert Shapiro, a former undersecretary of commerce for President Clinton and a senior policy scholar at Georgetown's Center for Business and Public Policy.

A default would send both bond and equities markets into a freefall. It would also wreck the standing of U.S. Treasury bills, which currently have a Triple-A rating, the highest in the world, which has taken centuries for the U.S. to develop, experts say.

U.S. Treasuries make up the so-called safe part of investment portfolios held by institutional investors as well as small-time investors through 401(k) retirement plans or as a component of mortgages. Just as important, Treasuries make up enormous parts of some sovereign holdings. China and Japan each owns about $1 trillion in U.S. debt. In the event of a default these countries would be tempted to unload their holdings, causing bond prices to plummet, and interest rates to soar to compensate for risk.

A Default Could Devastate Small Businesses

A default would lead to increased borrowing costs for everything and everyone, including small business bank loans, credit card loans, and other forms of financing. It would be the end of the virtually free ride the country has had since World War II, in which the government has been able to finance its activities for almost nothing.

"No one would want to buy [U.S. Treasuries] and we will still need to raise capital from China, but under which conditions can we do this?" Laura Gonzalez, professor of finance and business economics at Fordham, says, adding interest rates would rise, and financing of all kinds would automatically become more expensive.

In short, we could wind up like Greece, with lots of sovereign debt nobody wants to buy, experts say.

And rising interest rates would cause an immediate drag on the economy, says Jonathan Citrin, founder and executive chair of investment advisory Citrin Group and an adjunct professor of finance at Wayne State University. Every 20 to 30 basis point move upward in yield on the 10-year Treasury could decrease GDP by 1 percentage point annually, Citrin says.

Rising interest rates would also work against the low-interest monetary policy established by the Federal Reserve, which Chairman Ben Bernanke has kept in play by buying bonds and maintaining the federal funds rate near zero percent.

What's more, the dollar would also weaken, and could potentially lose its place as an international currency, and one used to value commodities such as oil. While that may boost exports in the short run, the costs to the economy and to small businesses would be enormous.

Small investors are likely to abandon crowd-sourcing, banks are likely to stop lending again, except to the most creditworthy small businesses, and venture capital companies would have leverage to push company values down and their ownership stakes up, says Mitchell Fillet, a professor of business and finance at Fordham University.

"VCs will deploy their money but by using different models and at lower valuations, because they can," Fillet says.

And for small businesses that depend on Small Business Administration 7(a) and 504 loans for their businesses, "you could say goodbye to the SBA for a year," Fillet says. It would take that long for the SBA to get its house in order again and respond to the backlog of loans and loan requests. That could take $80 billion of small business lending out of the market, which includes the guaranteed and non-guaranteed portion of the SBA loans, Fillet says.

Default Threat Already Dents America's Global Reputation

The threat of default and the government shutdown have already begun to destabilize markets, and they've made small business financing harder to get. The SBA has been shut down since October 1, and since that time critical loans are not going out to small businesses depending on them to finance growth.

"There's a direct damage to small businesses every hour this goes on, because these are highly credit-dependent businesses," Fillet says.

Shapiro says that the closer the U.S. gets to the debt default without signs of a resolution, the more it will rattle markets.

U.S. markets fell on Monday, with the Dow Jones Industrial Average down nearly 1 percent to 14,936. The S&P 500, which represents a broader basket of companies, was also down nearly 1 percent to 1,667. The dollar fell against most major world currencies. The yield on the 10-year Treasury fell 0.01 percentage points on Monday to 2.65 percent.

As is true for anyone who borrows, credit rating is critical, and defaulting goes against the business ideals of nearly every politician in Washington.

"One of the greatest assets of the U.S. is the perception around the world for half-a-century that the U.S. is the single most stable, conservative, and reliable government," Shapiro, former Clinton commerce undersecretary says. "The value of this asset…is incalculable and loss of it will have a very longterm effect, and if we come right up to a default, markets will not forget this."

IMAGE: Getty Images
Last updated: Oct 7, 2013

JEREMY QUITTNER | Staff Writer | Staff Writer, Inc. and Inc.com

Jeremy Quittner is a staff writer for Inc. magazine and Inc.com. He previously covered technology for American Banker and entrepreneurship for BusinessWeek.




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