Bernanke: U.S. default would cause 'major crisis'

@CNNMoney July 13, 2011: 1:19 PM ET
Bernanke: U.S. default would cause 'major crisis'

Testifying before the House Financial Services Committee Wednesday, Fed Chairman Ben Bernanke told lawmakers a U.S. default could send shockwaves through the world.

NEW YORK (CNNMoney) -- How much clearer can Ben Bernanke be?

The Federal Reserve Chairman has issued a stern warning to Congress repeatedly this year: if it fails to raise the U.S. debt ceiling by Aug. 2, the economic fallout could be "catastrophic," "self defeating" and "dire."

And yet, here we are in mid-July, with the country only three weeks away from a possible default, and Bernanke is repeating his warning again -- this time in his semi-annual monetary policy report to Congress.

"Clearly, if we went so far as to default on the debt, it would be a major crisis because the Treasury security is viewed as the safest and most liquid security in the world," Bernanke said, indicating such an event would raise interest rates and send shockwaves rippling through the entire global system.

And contrary to what some Republicans have proposed, just paying interest on the debt to bondholders may not preserve the nation's pristine credit rating, Bernanke said.

"It's possible that simply defaulting on our obligations to our citizens might be enough to create a downgrade in credit ratings and higher interest rates for us, which would be counterproductive, of course, since it makes the deficit worse," he said.

Debt ceiling: Chaos if Congress blows it

If Congress does not pass the debt ceiling by Aug. 2, the Treasury Department will not be able to pay at least 40% of its bills -- possibly including payments to Social Security recipients and military pay.

Bernanke also indicated the U.S. economy is at a crossroads, and the central bank is prepared to either provide further stimulus or pull back from intervening.

"On the one hand, the possibility remains that the recent economic weakness may prove more persistent than expected and that deflationary risks might reemerge, implying a need for additional policy support," he said in prepared testimony, indicating the Fed stands ready to provide additional stimulus if the recovery falters.

While those remarks immediately gave U.S. stocks a boost, the Fed chairman was quick to follow up that statement with a completely opposite idea -- showing it's not really clear which direction the economic recovery is heading right now.

"On the other hand, the economy could evolve in a way that would warrant a move toward less-accommodative policy," he said.

From November until June, the Fed bought $600 billion in U.S. Treasuries as a way to boost the economic recovery.

Amid disappointing jobs reports in May and June, and other weak readings on the economy, critics have questioned whether that controversial policy -- known as the second round of quantitative easing, or QE2 for short -- has actually worked.

Debt ceiling: What you need to know

Bernanke cited statistics that private businesses have averaged 160,000 jobs created each month in 2011, and part of that could be due to QE2.

That said, the Fed is maintaining its weak forecasts for the year overall, expecting the economy to grow by only 2.7% to 2.9% in 2011.

Meanwhile, inflation remains a concern, Bernanke said. He had previously argued that higher consumer prices are merely "transitory", but he changed his tune slightly Wednesday and seemed more vigilant of inflationary pressures.

"Given the range of uncertainties about the strength of the recovery and prospects for inflation over the medium term, the Federal Reserve remains prepared to respond should economic developments indicate that an adjustment in the stance of monetary policy would be appropriate," he said.

--CNN senior producer Scott Spoerry contributed to this report.

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