What Is the Economic Impact of a Default on the US?
With the approaching X-date, the United States is facing a critical situation where it may not have enough funds to settle its bills. Both economists and politicians agree that a default on the debt would result in catastrophic consequences.
What is a default?
Although both parties use the term “default,” their interpretations differ. This distinction is significant as the Treasury Department’s definition of default is peculiar. Consequently, when Treasury officials discuss the ramifications of default, they are not referring to the same issue that is causing concern among bankers and economists.
Financial experts define default as the failure of a debtor to make their debt service payments, resulting in delayed principal and interest payments for Treasury bondholders. However, the Treasury has a broader definition of default, where any missed payment – caused by the government running out of funds — is considered a default, including the non-payment of bills.
To default or not to default?
It is possible for the United States to default, according to the Treasury’s definition, but it may not be as disastrous as commonly believed. Essentially, the government’s spending can be divided into two categories: debt service and all other expenditures.
It is important to note that if a missed payment arises as a result of a temporary cessation of government operations or a funding gap, similar to the situation in 2013, it will not be considered a default from the Treasury’s viewpoint. As Janet Yellen has stated, the United States has not experienced a default since 1789.
In the financial markets, there is a common saying that a missed payment is of no significance, regardless of the reason. Whether the cause is a debt repudiation, insufficient funds, or a payment blockage by a judge, it holds no weight.
What was in the past?
The Treasury must comprehend the rationale behind any given event. In 2013, federal payrolls were disrupted, but it must be emphasized that this event was not deemed a default by either the markets or politicians. The markets were convinced that it was not a default because the debt servicing of Treasury bonds remained uninterrupted, while politicians attributed the missed payments to “a lapse in appropriations” rather than a failure to raise the essential funds.
The situation is as follows: During the previous debt ceiling crisis, the Treasury devised a strategy to guarantee timely payment of Treasury bonds, even at the expense of other government payments. Nevertheless, Treasury Secretary Yellen clearly stated on Friday that this plan was never put forward to the president or approved. She also asserted that prioritizing specific payments is impractical.
The consequences of the default
It is imperative to exercise prudence when handling the situation. Disclosing the Treasury’s prioritization plan could embolden Republicans to recklessly exceed the x-date and lend credence to former President Trump’s unfounded assertions that a default would have no significant ramifications.
In the grand scheme of things, employing prioritization and adhering to it would mitigate the short-term impact on financial markets and the global economy, as missed payments would be akin to those experienced in 2013. A complete debt default, on the other hand, would have far more severe consequences.
The feasibility of prioritization and whether or not President Biden will choose to implement it remains uncertain until the X-date.
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