On the possibility of default.

An anonymous reader asked in an earlier comment thread, “Could you explain what would happen if the Oct. 17 deadline isn’t met?”

October 17th is the day that the federal government expects to hit its debt ceiling. In other words, on that day, the federal government will max out its credit card and it won’t be allowed to borrow any more money until it pays off some of its old debts.

That doesn’t mean the federal government will cease all operations, or stop collecting taxes, or stop spending money. It can keep operating, collecting taxes, and spending money. It just won’t be allowed to borrow any additional money until (A) the debt ceiling is increased, or (B) enough old debt is retired to make some room underneath the debt ceiling.

The big fear now is that if the debt limit is not increased by Thursday, the federal government will default— that is, if the government owes you money on Friday, it won’t be able to pay you. That would be bad because an IOU from the federal government is supposed to be one of the most (or the most) safe and secure financial investments on Earth. And suddenly a lot of people, businesses, and other governments who’ve lent money to the federal government in good faith will realize that they may not get their money back in full. And that causes worldwide economic turmoil unless and until the federal government gets its act back together, but even then investors may no longer view it as trustworthy. And then people/businesses/governments are less willing to lend money to the federal government, which suddenly has great difficulty funding its daily operations, and has to either cut spending, increase tax revenues, or inflate the currency.

Default is the big fear. But default doesn’t have to happen, even if the debt ceiling doesn’t get raised by October 17th. The federal government can cut spending or it can raise taxes. Neither’s a pleasant option, but default would be far worse. And perhaps because default would be far worse, default is legally and constitutionally the last resort. The feds have to pay off their IOUs before they spend a dime on any other function of the government. That’s not just my opinion, that’s not just how I read the Constitution, that’s the last few centuries of financial and legal precedent. Bondholders– the “U” in “IOU”– get paid first. Not our military. Not Social Security or Medicare recipients. Not Congresscritters or other federal employees. Bondholders. And every day, the feds bring in several times the amount of cash necessary to pay off the bonds that come due every day.

So if October 17th comes and the debt limit hasn’t been raised, expect more parts of the government to shut down because of spending cuts. It won’t be pretty, but default will still be a long ways off– unless the President unilaterally decides to shaft the bondholders, which I’m sure would never ever happen in a million years.

6 comments

  1. Has nobody in the government ever said “hey our debt is too high, why dont we pay some stuff off first.” ( that might be a stupid question, but I know next to nothing about economics or the government)

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    1. The feds pay off debt all the time, on time, on a regular basis. That’s why default (failure to repay debt on time) was so scary– it hasn’t happened here in centuries. The feds are constantly paying off debt, but also constantly taking on even more debt (borrowing even more money).

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