Debt Ceiling Myth Debunked: The Federal Government Will Not Default No Matter What


The New York Post published a piece by Caroline Baum titled “Obama’s Phone Default Drama” that is quite enlightening. The basic premise is that the U.S. government is not going to default on its debt, regardless of whether Congress increases the country’s debt ceiling.

No doubt, Republicans will use the debt ceiling issue to encourage the president and Congress to decrease spending prospectively. The current debt ceiling stands at $16.4 trillion. A “showdown” between Obama and liberal Democrats, and conservative Republicans in the House of Representatives will be disruptive, and the latter will likely “hold the debt ceiling hostage” to get spending concessions. But what does it all mean?

For one thing, our country will not default on its debt payments, claims Baum, because “tax withholding from most of our paychecks each month exceeds the interest the Treasury owes on its debt outstanding.” In November, federal interest was $25 billion for the month compared to $167.7 billion of tax receipts.

The government cannot pay all of its bills for any length of time without borrowing because it is now borrowing 40 cents of each dollar it spends. Yet, interest payments on debt would be the highest priority. Debt maturities could be rolled over without a problem because they would not increase the overall federal debt.

In terms of timing of payments, the Government Accountability Office concluded, “We are aware of no statute or any other basis for concluding that Treasury is required to pay outstanding obligations in the order in which they are presented for payment.”

Translation: the Treasury is going to pay its debt service costs first to prevent any further downgrades to the country’s credit rating that would arise from a technical payment default.

Still, there could be repercussions if the debt ceiling is not raised for an extended period of time. Surely, the bond market will hike the cost of borrowing for the U.S. if politicians continually raise the specter of default, as they did last year during the previous debt ceiling brouhaha.

Using the debt ceiling for political purposes, therefore, is irresponsible and will cost our country money. In 2011, the GAO estimated that politicizing this issue resulted in $1.3 billion of higher interest expense as bondholders reacted to the rhetoric emanating from Washington.

Let’s return to the other implications of deferring a compromise on the debt ceiling. The government could be temporarily shut down resulting in some hardships to those who rely on government disbursements, such as Social Security recipients. Medicare and Medicaid would also have to wait for money to make distributions. And, the military might have to delay the payment of salaries. All these things would occur only if there is an impasse. One side or the other will probably blink before this actually happens.

As Baum notes, the debt ceiling has “nothing to do with the debt problem. It merely allows Treasury to borrow what Congress has already spent. It does not authorize new spending commitments.”