By Jay Powell, BPC Visiting Scholar and former Under Secretary of the Treasury for Finance
On Monday of this week, the Chairman of the Treasury Borrowing Advisory Committee weighed in with a letter setting forth the risks associated with any default in the Treasury market. It is a strong letter, and you can’t say it much clearer than this: “Any delay in making an interest or principal payment by Treasury even for a very short period of time would put the U.S Treasury and overall financial markets in uncharted territory and could trigger another catastrophic financial crisis.” It is difficult, although not quite impossible, to find experts who disagree. It would be crazy to run the experiment.
Fortunately, it is highly unlikely that we will come anywhere near a bond default. As the crisis evolves, the realities of government spending will eventually dictate the politics and the outcome. Congress will be forced to raise the debt limit well before we face the ultimate self inflicted wound of a bond default.
Treasury has projected that it will hit the debt limit no later than May 16. If the limit is not raised, Treasury will then deploy “extraordinary measures” that will generate about $230 bn in cash and enable the government to pay its bills for another eight weeks. This period is disruptive and may drive up interest costs, but it is manageable. In fact, we have hit the debt ceiling and lived through “extraordinary measures” a half dozen times over the last 30 years.
The real and final deadline for action to raise the debt limit is the moment when the $230 bn is spent and the government can no longer pay all of its bills – no later than July 8, under current projections. In the past, we have managed to resolve every debt limit impasse before running out of cash. That is because the effects of failing to do so would be extraordinarily negative for our economy and the markets, not to mention the political careers of those held responsible by voters.
No one knows exactly what would happen if we cross that line, but it won’t include a bond default. The government would have to rely solely on incoming cash to pay its bills. Although there is no explicit legal authority to pay some bills but not others, it is a safe bet that the federal government would do so, if only to avoid such a default. Incoming receipts would be more than adequate to cover bond interest , which represents less than 7% of spending.
What about other spending? On average, our revenue stream covers roughly 60% of what we spend. We borrow the remaining 40%, or about $125 bn a month. So let’s identify the 60% of federal spending that has the strongest claims, and assume for simplicity that all other spending is instantly reduced to $0.
The list of bills that we must pay in all cases would certainly include net interest on the debt; entitlements like Social Security, Medicare and Medicaid; veterans’ benefits; and military spending including salaries, health care and overseas combat operations. The list could go on and on, but let’s stop there. Clearly, a vote to instantly and drastically curtail any of these payments would be political suicide.
But these payments make up over 75% of FY 2011 year to date expenditures. Oops! Without a debt limit increase, we would be roughly $45 bn per month short of being able to pay only these sacrosanct bills and nothing else. Hmmm. . . . But couldn’t we find some softer targets within that 75%? Yes, but there are also many hard targets in other departments (such as State, Homeland Security and Justice), and we are assuming that all of these other departments are instantly cut to $0. Inevitably, some “untouchables” would be not only touched, but eviscerated.
During the recent battle over the 2011 continuing resolution, we saw how hard it was to cut less than $30 bn in actual spending over a six month period. Why would anyone imagine that we could cut $125 bn a month without slaughtering a whole herd of sacred cows?
Conclusion: Because a failure to raise the debt limit before we run out of cash would force us to make instant, enormous cuts in widely popular programs, Congress will not fail to raise the debt limit. The question of defaulting on our debt will not directly arise, and that is a very good thing.