BEYOND THE NUMBERS
Senate Minority Leader Mitch McConnell (R-KY) is threatening to risk a default on the national debt unless President Obama agrees to large spending cuts. “We simply cannot increase the nation’s borrowing limit,” he writes, “without committing to long overdue reforms to spending programs that are the very cause of our debt.” But playing politics with the debt ceiling is a dangerous and inappropriate game.
Sometime around late February, the Treasury will run out of room to borrow more money without exceeding the legal limit on the public debt. At that point, if Congress does not raise the debt limit, the federal government will not be able to meet all of its financial obligations, including required payments to bondholders, service members, veterans, and contractors.
Default would have shattering consequences.
First, federal interest costs would be permanently higher because, as Treasury Secretary Geithner has stated, “default would call into question, for the first time, the full faith and credit of the U.S. government.” The damage to the Treasury’s reputation would be irreparable. Investors would no longer treat Treasury securities as a risk-free asset once the government failed to meet its obligations in full and on time, and they would demand higher interest rates on federal securities to compensate for the new risk. Private borrowing costs could rise, too, since interest rates on credit cards, mortgages, and business loans are often tied to Treasury rates.
Second, if the government could not borrow and therefore could not spend more than it collected in revenues, it would have to cut spending abruptly by about one-quarter. The Treasury, Secretary Geithner says, could be “forced to stop, limit, or delay payment on obligations to which the Nation has already committed — such as military salaries, Social Security and Medicare, tax refunds, contractual payments to businesses for goods and services, and payments to our investors.” If the situation continued for very long, the drag on the economy would be far worse than the “fiscal cliff” that policymakers have just avoided.
Third, a default could impair the solvency of mutual funds, banks, and other financial institutions with substantial investments in Treasury securities, causing serious ripple effects. As we learned in 2008, a loss of confidence in a few systemically important firms can lead to a worldwide financial crisis, a global economic slowdown, and steep job losses at home.
Notwithstanding conventional wisdom to the contrary, raising the debt limit simply allows the government to pay bills that it has already incurred; it doesn’t allow the government to incur new ones. As we have previously pointed out, “the amount of debt outstanding reflects Congress’s [previous] tax and spending decisions and the state of the economy, not the level of the debt ceiling. Citizens who urge their members to vote against raising the debt limit as a way of expressing displeasure with federal borrowing are picking the wrong target.”
To be sure, policymakers need to achieve about $1.2 trillion in further policy savings over the next 10 years to stabilize the federal debt as a share of the economy. They should do so through a balanced package of both spending cuts and revenue increases. But threatening default should not be part of the discussion. If the process of deficit reduction ends up destroying the nation’s credit rating, that would prove a Pyrrhic victory.