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New alarms sounded on debt impasse harm to U.S. and global economy

Day three of the government shutdown included two new warnings on what would happen if Congress doesn’t increase the U.S. government’s borrowing limit. The warnings increased pressure on lawmakers Thursday as the government crept toward an Oct. 17 debt deadline. 

Failing to raise the debt limit would be a serious blow to the world economy, International Monetary Fund Managing Director Christine Lagarde warned Thursday in a speech in Washington.

“The (federal) government shutdown is bad enough, but failure to raise the debt ceiling would be far worse, and could very seriously damage not only the U.S. economy, but the entire global economy,” she said. “So it is ‘mission-critical’ that this be resolved as soon as possible.”

Lagarde’s warning echoed those of private-sector economists as worries grow over the ability of Congress and President Barack Obama to figure out some agreement that would permit the $16.7 trillion limit to be raised and allow the government to keep borrowing money.

Meanwhile the Treasury Department issued a report Thursday detailing the economic damage of the debt limit impasse in the summer of 2011 and predicting that worse would occur if Congress doesn’t take action to raise the borrowing limit before Oct. 17, the date on which the Treasury says it will have exhausted all extraordinary measures to stay within the current borrowing limit.

Already, the Treasury report said, “We may be starting to see some tentative signs that the current debate is affecting financial markets.” It pointed to the fact that yields on Treasury securities that mature at the end of October are higher than bills that mature immediately before or after, which it said might suggest investors have worried about possible delays in payments on those securities.

A failure to repay investors who’d purchased Treasury securities would be a default. It would have ripple effects on financial markets since some financing deals rely on Treasurys as collateral for loans and defaulted securities can’t be used as collateral.

The Treasury report said that a default on U.S. government securities would cause an economic crisis of the magnitude of the one in 2008 and have effects “including high interest rates, reduced investment, higher debt payments, and slow economic growth, (that) could last for more than a generation.”

By Oct. 17, the Treasury says it will have only about $30 billion in cash - in addition to daily tax receipts -- to pay the government’s bills, including repayment of previously issued debt.

As a result, the government wouldn’t be able to send out Social Security and other benefit payments on their normal schedule. 

“They are sending a pretty big warning sign that I think a lot of Americans can recognize that this would be uncharted territory,” said Brian Levitt, senior economist at Oppenheimer Funds in New York.

Levitt said that hitting the debt limit would mean, “Automatic austerity – an awful lot of austerity in a very short period of time. You’re only going to be able to cover at most two-thirds of federal spending so one third does not get paid, depending on whether or not the Treasury can prioritize (payments) – which is a whole other issue. It’s a big hit to confidence and a big hit to economic activity.”

The Bipartisan Policy Center said in a report last month after the limit is reached and the federal government’s borrowing comes to a halt, “on a day-to-day basis, handling all payments for important and popular programs (e.g., Social Security, Medicare, Medicaid, Defense, and military active duty pay) will quickly become impossible.”