Is Default On The Table?
Share and Follow

Congress’s debate over the debt ceiling has raised fears of a government shutdown, and, sure as night follows day, such a prospect has inspired still greater fears of default. At least that is the story presently circulating in both the financial and the daily media round. It happens every few years when the nation’s outstanding debt approaches an admittedly arbitrary legal limit and Washington goes through agonies over the prospect. There can be no denying that theoretically default is possible. Practically speaking, however, it has never been a real possibility. Nor is it one today. Even in an extended government shutdown, Washington has resources that will allow it to meet its principal and interest payments in full and on time.

At base is Congress’s understanding how important it is for the government to meet these obligations. Washington has always prioritized payments on its debt and always will because, behind the daily childishness that typifies the capital, both the House and the Senate know that the stability of the government, the financial system, and hence on the economy depends on the federal government’s reputation as a reliable credit. In the 234 years since Alexander Hamilton established the reliability of federal debt as the lynchpin of the country’s financial system, Washington has never missed an interest or principal payment, even in the most trying times — the Great Depression, for instance, the Civil War, or the Second World War. It is not likely to give way now because of a Congressional impasse.

Apart from this powerful fact, Washington has several means to meet its obligations even if Congress balks for a while at raising the debt ceiling. Treasury Secretary Janet Yellen all but admitted this recently when, after first engaging in needlessly inflammatory remarks, she admitted that the Treasury has enough cash on hand to meet its obligations through June. Five months might not seem like a lot in the grand scheme of things, but no debt debate has ever lasted that long, and it provides considerable wiggle room before Congress can arrive at a more lasting resolution of the matter.

Even if in a few months, the nation’s outstanding debt abuts the limit, Washington can reallocate funds from one presumably less vital activity to other more vital activities, such as making good on its interest obligations. Politicians will argue endlessly about what is essential. In the past, they have decided that they can close national parks, for instance, and furlough thousands of federal administrative personnel to have the cash to pay interest on the debt and also to make Social Security payments. Some citizens are inconvenienced, and some suffer hardship, but when Congress reaches a compromise on raising the debt ceiling, as it inevitably does and will, services are restored, and the furloughed workers receive back pay.

Simple arithmetic also takes some of the edge off worries. If the Treasury issues debt to pay off a maturing bond, which incidentally is the way it proceeds generally, the outstanding amount of debt does not increase in the least. The maturing debt decreases the amount of debt outstanding, while the new debt issued to pay off the old bonds brings the total back up to where it was. On this basis, there is no difficulty making good on principal payments at least, even if the nation finds itself up against a legal debt limit.

Another possibility, though never before used, is to tap the Federal Reserve’s (Fed’s) huge portfolio of Treasury debt. According to the Fed’s own accounting, it holds some $5.2 trillion in Treasury debt. That is almost a full year of federal spending. In a pinch, the Fed could simply forgive all or some of this debt. That might seem like a drastic move, but since for practical purposes the Fed is part of the federal government, such an act would amount to little more than moving money from one pocket to another. Ultimately, such a use of these funds could have inflationary effects, but that is a separate matter from default.

If the history is any guide, and it should be, Washington will not likely need to resort to such extreme measures. The longest such problems have persisted can be measured in weeks rather than months. The sequence of events is always the same. The kabuki play goes like this: The Treasury secretary – whether Republican or Democrat – points out the debt ceiling constraint and attaches some ominous language around what will happen if the ceiling is not lifted immediately. Secretary Yellen has already delivered these, her lines in the drama. Media outlets enlarge on the fears expressed by the secretary. That part of the play is presently being enacted. Holdouts in Congress refuse to compromise. Once, however, the political winds make it plain who will get the blame for the disruption, Congress quickly manages a “bipartisan” compromise that lifts the ceiling before the need for extreme measures much less default. That is the likely path over the next few weeks.

Share and Follow