GOLDMAN: If The Debt Ceiling Isn't Raised And The Treasury Runs Out Of Cash, Then Say Goodbye To 9% Of GDP

The government shutdown is the result of Congress’ failure to make a budget deal.

However, the shutdown has taken attention away from a much bigger policy risk: the impending debt ceiling, which is when the U.S. Treasury is no longer able to borrow money by issuing debt.

Economists as well as policymakers on both sides of the aisle agree that failure to raise the debt ceiling and defaulting on U.S. debt would be far too devastating to the economy.

As such, most people are confident that Congress will ultimately raise the debt ceiling before it is reached on October 17.

But considering Congress’ track record, it’s safe to assume there is a non-zero chance that we do hit the debt ceiling.

And while it is not their base-case scenario, Goldman Sachs economists Alec Phillips and Kris Dawsey provided an estimate of the economic cost of the government depleting cash after crashing through the debt ceiling.

“If the debt limit is not raised before the Treasury depletes its cash balance, it could force the Treasury to rapidly eliminate the budget deficit to stay under the debt ceiling,” wrote Phillips and Dawsey in a note distributed to clients on Saturday night. “We estimate that the fiscal pullback would amount to 9% of GDP. If this were allowed to occur, it could lead to a rapid downturn in economic activity if not reversed quickly.”

Here’s more from Phillips and Dawsey’s 13-page note:

Growth, Not Treasuries, Ultimately at Risk in a Debt Limit Mishap

Failure to raise the debt limit would eventually lead to a sharp reduction in spending and could result in a rapid downturn in near-term economic activity. A very short delay past the October deadline — for instance, a few days — could delay the payment of some obligations already incurred and would create instability in the financial markets. As noted in prior research, this uncertainty alone could weigh on growth.

But a long delay — for example, several weeks — would likely result in a government shutdown much broader than the one that started October 1. In the current shutdown, there is ample cash available to pay for government activities, but the administration has lost its authority to conduct “non-essential” discretionary programs which make up about 15% of the federal budget. By contrast, if the debt limit were not increased, after late October the administration would still have authority to make most of its scheduled payments, but would not have enough cash available to do so.

Using our cash flow projections as a guide, we estimate that the revenues the Treasury will receive in the month following the October 17 deadline would equal only about 65% of spending going out, implying a far greater fiscal pullback than will occur as a result of the ongoing shutdown. In essence, a prolonged delay would force the Treasury to rapidly eliminate the budget deficit to stay under the debt ceiling. (The deficit has significant seasonal fluctuations and CY Q4 is normally a higher-deficit period, offset by lower deficits or surpluses in other periods, particularly CY Q2.)

We estimate that the minimum pullback in spending that would be required to remain under the debt limit for one month without an increase would be equivalent to 1.7% of GDP (annualized). However, if the Treasury decided to set aside interest payments and make other payments in arrears, we estimate it would result in a pullback in primary (i.e., noninterest) outlays of 4.2% of GDP (annualized). In both cases, the effect on quarterly growth rates (rather than levels) could be even greater. If this were allowed to occur, it could lead to a rapid downturn in economic activity if not reversed very quickly.

Bottom line: the failure to raise the debt ceiling means economic devastation.

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