Costs of Crossing the X Date

• Crossing the X Date would be an unprecedented economic event with domestic and global implications, as evidenced by market reactions to recent debt limit standoffs.
• After reaching the X Date, the Treasury Department would be unable to pay a substantial portion of its bills in full and on time, potentially including critical expenses like military pay and government benefits.
• Confusion over delayed payments and the consequences of defaulting on some of our obligations would likely prompt a downgrade of the country’s credit rating and lead investors to demand a higher rate of return on Treasury securities.
• Even a short-term default could lead to higher borrowing costs and liquidity concerns for the private sector, increased unemployment, stock market losses, and GDP contraction.

Approaching the X Date

The U. S. federal government repeatedly finds itself in a familiar, yet avoidable, situation: on the brink of failing to meet its fiscal obligations. Once the nation’s debt limit is reached and the Treasury Department no longer has the ability to continue paying its bills using extraordinary measures and available cash on hand – a day we call the “X Date” – Congress will need to take action.

Policymakers are all too familiar with the debt limit from their battles over the past few decades. Indeed, previous close calls have revealed real costs of such brinkmanship. In 1979, after a debt limit showdown and technical glitches caused the Treasury Department to delay 4,000 payments on maturing securities totaling an estimated $122 million, short-term interest rates spiked by approximately 60 basis points. In both 2011 and 2023, even flirting with the X Date cost taxpayers: Standard & Poor’s downgraded the U.S. long-term sovereign credit for the first time in 2011, and Fitch Ratings followed suit in 2023. 

What is less understood are the costs associated with crossing the X Date. That is because Congress has avoided it, albeit narrowly on occasion, by raising or suspending the debt limit each time and traditionally with bipartisan support. In a world where the Treasury Department is only able to pay a portion of its bills, the choices about which obligations get paid and when “would not be pretty,” according to Federal Reserve Chair Jerome Powell if the X Date were to be crossed.

Missed Payments

If Congress fails to act and crosses the X Date, the Treasury Department would find itself unable to pay all the government’s bills. It would be dependent on incoming daily revenues, and given the massive federal deficit, those resources would be insufficient to cover committed spending on most days.

While the Treasury Department may have the capability to prioritize certain obligations—such as interest and principal payments on debt—an immediate cash flow shortage would force the federal government to miss or delay critical payments. These could include programs that touch nearly every American, from Social Security, Medicare, and Medicaid to military and federal salaries and veterans’ benefits. The number of missed checks would likely grow rapidly as the standoff intensified, causing widespread confusion and income shocks for households and business owners who rely on regular payments from the government.

U.S. debt is frequently viewed by global financial markets as one of the safest assets in the world. Because Treasury securities are extraordinarily liquid and reliable, investors carry them at relatively low yields and trade them at a premium (with lower interest rates) relative to other securities. If that debt starts being priced based on our nation’s willingness to pay its bills rather than its ability to pay, the ramifications could range from short-term market confusion to long-term economic damage.

In 2013, Fitch Ratings stated that delays on key payments—whether Social Security benefits, tax refunds, or payments to federal contractors and employees, among others—would likely lead to a downgrade. Given that many investment funds are required to hold only AAA-rated securities, another downgrade could force some institutional investors to divest from Treasury securities. Such a scenario could harm investor confidence and reduce demand for Treasuries, further driving up borrowing costs for the federal government.

Such a disruption to the market for Treasury securities from crossing the X Date would increase uncertainty in the economy, potentially leading to higher interest rates throughout—not just for the federal government. American households could face higher mortgage costs and interest payments on consumer loans, such as credit cards and car payments.

A 2013 study from Macroeconomic Advisers analyzed the potential impacts of two scenarios—a brief period where payments were missed and an extended, two-month impasse—finding that ripple effects would immediately reverberate through the economy. Under the former scenario, they concluded that even if the Treasury Department is able to prioritize interest payments, investors would be spooked by the unprecedented nature of such an event in the United States, causing the fear index—a measure of near-term volatility in stock prices that serves as a general marker for uncertainty—to spike. The authors projected that the unemployment rate would likely rise quickly in response by an estimated 1.6 percentage points.

A memo presented at the 2013 Federal Open Market Committee meeting anticipated that in the event of payment delays, cash flows for households and firms that rely on payments from the government would be severely disrupted. This scenario would likely make consumers more cautious about spending—perhaps even after Congress resolves the debt limit impasse—further threatening economic stability.

A prolonged debt limit stalemate and subsequent recession—as outlined by Macroeconomic Advisers’ other scenario—would be characterized by even more extreme volatility, as missed payments spread throughout the economy. In this extended event, the size of the U.S. economy could contract by as much as 8%, the same study found based on 2013 data. As federal budget deficits grow even larger, the impacts could be more severe.

Government Debt Default

Even a short-lived default on U.S. debt would almost certainly roil financial markets. In fact, Federal Reserve staff have previously cautioned that a default of only one to two days could cause short-term Treasury security yields to rise significantly, and that a weeks-long default could prompt investors to demand premiums on some of these securities comparable to those on AAA corporate bonds, a substantial increase. Additionally, a contagion effect could set in, affecting longer-term Treasury securities not perceived to be at risk of delayed principal or interest payments. All of this would raise borrowing costs for the federal government.

Even a modest loss of confidence in Treasury securities could imperil money market funds, low-risk mutual funds that invest in high-quality, short-term debt instruments and cash equivalents. Many of these funds are heavily invested in Treasury securities. For example, one of the largest money market funds—the Vanguard Federal Money Market Fund—has more than 35% of its assets in Treasury bills. In addition to government securities, money market funds often hold short-term corporate debt that companies use to finance immediate obligations, including payroll and inventory costs. Accordingly, a run on money market funds—where investors, spooked by a Treasury default, rush to pull out their money—could also precipitate a corporate liquidity crisis.

Money market funds are not the only investment vehicles that a default could jeopardize. The government failing to make good on its obligations could cause the stock market to drop and batter individual retirement accounts, which are heavily invested in equities. Additionally, the future of the U.S. dollar as the world’s main reserve currency could be threatened if the X Date were crossed and global investors become reluctant to hold U.S. dollar-denominated assets, leading to a decline in demand over time.

A default would also open a legal Pandora’s box, whereby affected debt holders could sue the government for damages—potentially costing taxpayer money and further damaging confidence in and the credibility of the full faith and credit of the United States.

An Avoidable Crisis

While some of the financial risks to crossing the X Date can be quantified, the “unknown unknowns” are most concerning. Ramifications would depend on whether the Treasury Department is indeed able to prioritize debt payments, how long it takes Congress to reach a compromise on extending the debt limit, and the degree to which global investors’ confidence is shaken.

What makes America’s flirtation with default particularly unique is that failing to raise the debt limit would be a purely voluntary decision by federal lawmakers to stop paying our bills. When other nations have defaulted, it has been because they do not have the ability to continue servicing their sovereign debt. But we do.

The bottom line is that even without clairvoyance, it is reasonable to assume that the U.S. defaulting on its obligations would not only pose great risk to the economy, but also to the nation’s global reputation for years to come.