Commentary Magazine


The Wages of Default

There has been much wringing of hands and gnashing of teeth over the prospect that the United States Government might actually default if Congress and the President can’t agree to raise the debt ceiling by Thursday, when, according to Treasury Secretary Jack Lew, the Treasury will be empty.

Of course, the Treasury receives on average about $14 billion a business day in receipts. That vastly exceeds the daily interest costs on the debt.  Old debt can be simply rolled over without increasing the total debt. But apparently the Treasury’s system of paying the bills is mostly on autopilot and there is no prioritizing. So interest on the debt and paying a contractor for roadwork stand in the same line. Still, I find it impossible to believe that emergency action cannot be taken to see that default does not occur. If such action doesn’t comport with every jot and tittle of the law, so what?  As Justice Robert H. Jackson wrote in 1949, in the common paraphrase of the actual quote, “the Constitution is not a suicide pact.”

And while a contractor being paid late would be, at the least, an embarrassment, a real default would be, if not financial suicide, a body blow to the American—and thus the world—economy. Something like a quarter of GDP flows through the federal government in the course of a year. Stopping that flow, or even curtailing it, would be about as disruptive to the economy as anything short of nuclear war could be. Millions of families depend on Social Security and other federal payments. They would stop. Consumption would thus decline markedly and that would ripple through the economy throwing us back into recession. The world would follow along in short order.

(It has been argued that Social Security could continue because the Social Security Trust Fund has many billions in federal bonds that it could sell to keep the checks flowing. Unfortunately, they are special Treasury bonds and are not negotiable. They can only be sold back to the Treasury at par. In this situation the Treasury would have no money and would be unable to raise money in the bond market.)

And the blow to American prestige would be immense.  The cost of future borrowing would increase, as the risk of a new default—long thought non-existent—would now be priced in.

It has been widely said, including by President Obama that the United States has never defaulted on either the principal or interest of its debt. That’s not so.

The United States was in default in the 1780’s, after the Revolutionary War and Britain’s closing of West Indian ports to American ships threw the country into deep depression. It was that financial crisis that led to the present Constitution.

Then in November of 1814, with Washington, D.C., in ruins and with American soldiers going unpaid, the Treasury defaulted on some bonds. The default was temporary and quickly forgotten as the war ended soon afterwards.

In 1979, another dust up over the debt ceiling caused the Treasury to be late, for up to a week, on redeeming $122 million in Treasury bills. The Treasury blamed it on new word-processing software and called it a “delay,” but the market called it a default and the interest rate on T-bills rose 0.6 percentage points and stayed up. A study in 1989 calculated that that cost us $12 billion.

But I suspect that the best guarantee against a default this time around is the certainty that any default would result in a firestorm of anger on the part of the American population. A recent poll showed that the people are in a throw-the-bums-out mood, with 60 percent of the people agreeing that everyone in Washington, including their own representatives, should be kicked out of office. If the country defaults that will go to over 90 percent and a lot of bums will be thrown out come next November.