Federal Reserve Chairman Ben Bernanke warned on Tuesday that a failure to lift the government's $14.3 trillion debt ceiling risks a potentially disastrous loss of confidence in America's creditworthiness.
In comments that could give fresh impetus to talks on raising the legal limit on the nation's debt, Bernanke said the United States could lose its prized AAA credit rating and the U.S. dollar's special status as a reserve currency might be damaged if Congress fails to act soon.
Even a short suspension of payments on principal or interest on the Treasury's debt obligations could cause severe disruptions in financial markets and the payments system, he told a budget conference.
Inaction could also create fundamental doubts about the creditworthiness of the United States, and damage the special role of the dollar and Treasury securities in global markets in the long term, Bernanke added.
Investors worldwide view U.S. Treasury bonds as so safe as to be a near-equivalent of cash. That confidence helps keep U.S. borrowing costs low. The dollar, which has long been used as a reserve currency by many countries, is also seen as a good store of value.
Vice President Joe Biden and top lawmakers resumed budget negotiations on Tuesday in an effort to find trillions of dollars in savings that would give Congress the political cover to raise the debt ceiling before the government runs out of money.
The Treasury Department has warned that the government will begin defaulting on its obligations -- whether debt payments or other bills coming due -- if Congress does not increase the limit by August 2.
The longer-term (budget) problem is the aging population, and that's the thing that really needs to be tackled, said Lou Brien, market strategist with DRW Trading Group in Chicago. To conduct that debate by using the debt limit as a bargaining chip is kind of a dangerous game to play.
Bernanke repeated his calls for a long-term budget plan, but made clear he did not want to see the rise in the debt limit held hostage to a deficit-cutting plan.
I hope ... that such a plan can be achieved in the near term without resorting to brinkmanship, the Fed chief said.
He also renewed a warning that he had made a week ago that cutting the budget too sharply in the near-term could endanger the economy's recovery.
An advantage of taking a longer-term perspective in forming concrete plans for fiscal consolidation is that policymakers can avoid a sudden fiscal contraction that might put the still-fragile recovery at risk, Bernanke said.
The U.S. budget deficit is forecast to hit $1.4 trillion this year -- on par with a record reached in 2009.
Bernanke said a considerable portion of recent fiscal deficits was due to fallout from the recession, which led to lower tax revenues and higher stimulus spending.
Still, he warned large structural budget issues remained.
Developing a plan now for how to reduce that debt load over time could bolster economic activity today by keeping borrowing costs down and boosting confidence, Bernanke argued.
Maintaining the status quo is not an option, he said.
(Reporting by Pedro Nicolaci da Costa)