Those pay-checks will be in jeopardy again if the debt ceiling is not raised. Increases used to be routine: after all, Congress regularly approves budgets that include deficits and thus, arithmetically, lead to a higher national debt. But if Congress remains obdurate, the federal government will have to renege on some obligations. The Treasury hit the current ceiling of $16.7 trillion on May 19 and has since used book-keeping maneuvers to keep issuing debt and paying bills. On October 17, it says, it will have exhausted those tactics.
It will still have $30 billion of cash on hand, and will continue to collect taxes. But it will soon struggle to make several large payments: $12 billion for Social Security on October 23, $6 billion in interest on the debt on October 31 and $67 billion in payments for Social Security, Medicare and bureaucrats’ and soldiers’ salaries on November 1. By that date, analysts reckon, the Treasury will miss a payment on something.
But it may not be on the debt. Many analysts, including Moody’s, a credit-rating agency, believe that the Treasury will ensure that interest is paid before other obligations. The Treasury has suggested it does not have the technical ability or legal authority to prioritize one payment over another. It would be awkward, naturally, for politicians to argue that old, poor and sick Americans should forgo their government benefits so that foreign bankers and governments can continue to earn interest on their huge holdings of Treasuries. Picking among the many deserving Americans owed money by the government would be almost as hard.
Even if America does pay the interest on its debts, the economy would not be saved. To eliminate its deficit instantly the federal government would have to slash spending by 4 percent of GDP, assuming interest payments are made, according to JP Morgan Chase. If sustained, that would be enough to bring on a recession. Unlike with a shutdown, nothing would be spared: pensions, health care and military salaries would all be vulnerable.
If by choice or miscalculation the Treasury does miss an interest payment, it might not suffer as much as the rest of the financial system, in the short run. In theory, a default should cause the price of Treasuries to plunge and interest rates on new issuance (if and when it resumes) to soar. However, if default triggered panicked sales of stocks and other assets normally seen as riskier, the result might in fact be a rush into Treasuries. There are no “cross-default” provisions on Treasuries, which means that missing a payment on one does not automatically place the others in default. This, combined with the lack of ready alternatives, may deter banks, mutual funds, and sovereign-wealth funds from mass selling.
Nonetheless, a default would do lasting damage to the government’s finances. “What sets Treasuries apart is the fact that holders can turn them into cash at a moment’s notice either by selling or pledging them,” notes Wrightson ICAP, a broker. “Once Congress establishes the precedent that debt-service payments can be delayed on a political whim, Treasury securities will no longer be immune from liquidity risk.” America would have jeopardized the “exorbitant privilege,” as a French minister once put it, of borrowing in the world’s most trusted currency.
© The Economist Newspaper Limited, London (October 12, 2013)