If you’ve turned on the news during the past week, you’ve heard plenty about the government shutdown and the threat of reaching the debt ceiling. However, what many seem to fail to understand are the implications and consequences of reaching the debt ceiling.
The United States has a perfect record of paying its bills on time. When people lend money to the federal government by purchasing Treasury bonds, they are confident that they are investing in the safest asset in the world. But if we default on our debt for the first time in history, that trust will vanish. The United States would have to pay higher interest rates to borrow money if investors saw that Treasury bonds were actually a risky asset. This would lead to higher interest rates for every other type of borrowing, both in the U.S. and around the world, likely causing a new worldwide recession. It could also cause the value of the dollar to plummet. The resonant effects on the financial system and on the U.S. and world economies would be disastrous.
So why is it such a problem? Can’t the government just pay the investors and cut other parts of federal spending instead? It might be forced to do so, but that would mean immediate and major reductions in income for many Americans as a result of stopping or sharply reducing things like Social Security benefits, payments to doctors and hospitals through Medicare and Medicaid, defense spending, and various other government activities such as homeland security, food inspections, immigration enforcement, weather surveillance, medical research, and many others. In short, the political reality is that these payments also cannot be stopped for more than a very few days without major damage occurring throughout the U.S. economy. If the government cannot borrow any more money, it would need to reduce a large fraction of its spending, either on interest payments (which would lead to financial default), on entitlements such as Social Security and Medicare and Medicaid benefits, or on discretionary spending on defense, education, and the full range of government programs. If this happens, the economy could be thrown into another recession, possibly worse than the one we’re working our way out of now. Of course, the Congress could also decide to increase taxes so that the government would be taking in enough money to meet the country’s obligations. However, it would require legislation for which there is no political support. Also, such changes could not be put in place quickly enough to resolve the pending crisis with the debt ceiling.
Treasury Secretary Jacob Lew estimated that on October 17th, the government will have 30 billion dollars on hand – not nearly enough to cover the payments that need to be made, seeing as the government spends up to 60 billion dollars a day. The debt ceiling is an arbitrary limit that prevents the government from borrowing to meet the expenses that it has already agreed to pay. If Congress fails to increase the debt ceiling in time, either the nation’s credit will be damaged with possible catastrophic effects on the world’s financial system, or the domestic economy will suffer a severe blow that will lead to major hardships for many American citizens.