US debt limit: why necessarily a default without limit increase?

So, as I understand it, if Congress does not pass an extension of the US debt limit by Thursday, the US will default on its payments to Treasury bondholders, which all sane people agree would be something of an economic disaster.

But I am somewhat puzzled. The Federal government is currently shut down, except for essential employees and services, and thus spending relatively little money. Yet, tax rates are unchanged, and the US government’s income stream from federal tax payments has not been affected: key parts of the IRS are still operating, etc.

The US has been running a budget deficit for many years, but interest payments on existing debt are only about 10% of expenditures, and so perhaps 20% of incoming tax revenues.

If Congress does not pass a debt ceiling increase, why will the US necessarily default? Surely we can continue to make payments to bondholders from the existing tax revenue stream, and with the majority of the Federal government shut down, wouldn’t we in fact still actually be operating at a surplus until the government is re-opened?

The “majority” of the things the federal government pays for, such as the armed forces, are not shut down at all. In reality, in terms of costs, only a small fraction is shut down, and much of the cost for that will be due to be paid (in back salary, etc.) when it opens up again.

the problem is a) expenses aren’t reduced that much, and b) there are no rules or regulations specifying how the Government will react in this situation. It has never come up before and no one prepared a plan for this. So while it seems likely that the Gov’t would pay interest on the debt to the Chinese (to cite one extreme possibility) before social security checks, it isn’t known what will happen. You can imagine the politics of that in today’s Washington. Certainly investors around the world can imagine that. That uncertainty is going to scare world-wide investors. And a large amount of debt is coming due. For reasons I am not certain of that debt can’t just roll over. Again I don’t know why, it would seem that it could. Perhaps it is a timing thing. We would have to pay off the debt before we could sell more-and there isn’t enough money in the bank to do that. Obviously the Gov’t can’t seek a short-term loan-that is the problem to begin with. The bottom line is that there won’t be enough $ available to honor the Gov’ts obligations and no one knows who will get shorted.

On the news they said the gov’t systems have no mechanism to pay one kind of check and not another. It was never anticipated when the antiquated computer systems were designed. So even if the politicians wanted to pay Chinese bond holders and not aunt Jeannie’s SS check, there is no way to do it.

It’s also illegal, so they never designed it to perform an illegal act. And while laws can change, they don’t normally change without warning; there’s no time to add in such capability.

The Treasury Department makes 80 million automatic payments every day. In the time it takes you to read this sentence, 4,630 payments were made. How do you propose to determine which payments should be made, and which can be deferred?

I think the simplest answer is that Congress has already authorized new spending that is either a law or a scheduled event and, on a cumulative basis, current account limit will be breached.

Nothing to do with incoming stream of taxes or sales of Treasury securities but rather, simple math of comparing cumulative current account and approved spending that needs to be paid.

It’s like your line of credit at the bank - say your LOC limit is $20,000 and you are out by 19,000 but you already scheduled delivery of furniture and new TV which would put you over 20,000 and thus breach the limit.

So, instead of paying attention when buying sh!t you have to haggle with the bank to increase your LOC limit.

It’s actually amazing how this game is being played out…

It all depends on the meaning of the word “default.” Traditionally, when it comes to sovereign debt, it means exactly what you say: failing to pay interest on bonds. That’s exactly what is meant when people say Argentina “defaulted” in 2001. There is, as you say, no reason at all why the Federal government should have to do that. Interest payments on Treasury obligations add up to about 10% of incoming tax revenue.

However…many have come to use the word “default” in this context to mean "not pay any of its bills when due, including salary to government drones, payments to contractors, income tax refunds, military pay, Social Security checks, Medicare reimbursements, block grants to states, the monthly minute tab on Obamaphones, the cost for the jet fuel to fly the President to Omaha to give a speech condemning the government shutdown…everything, from soup to nuts.

The “debt limit” on 10/17 is the date on which the Secretary of the Treasury says he will be unable to pay all the government’s bills when due unless he can issue MORE debt, that is, sell additional bonds. He can, of course, continue to roll over maturing debt into new debt, because that does not ADD to the outstanding debt. There are also some tricks he can pull here and there – and has actually for a while – to shift money around so that he isn’t technically adding to the debt limit. It’s quite tricky, because about 1/4 of the total debt is “intragovernmental” debt, meaning its debt one part of the Federal government “owes” to another; for example the Social Security Administration owns a huge amount of government debt. So does the Federal Reserve, although technically the Fed is not part of the government, ha ha ha. Both entities together own far more debt than individual owners of Treasuries, e.g. those in your 401k.

So what happens on 10/17? There are four sources of decision: (1) the most iron is the Constitution itself, and the only relevant portion is the Fourteenth Amendment, which say the debt of the United States “shall not be questioned.” Most people believe this means interest payments to bondholders must take precedence over everything else, meaning NOT paying bondholders and paying someone else instead would be unconstitutional on its face. A big no-no. But aside from that, the Constitution is silent. THen we have (2) statute, i.e. laws Congress has passed. Of course, most obligations of government stem in the first place from programs established by statute. Unfortunately, that does not mean the expenditures have been authorized. Congress spends your money in two steps: first, it creates programs and gives them a budget authorization. Then it actualy “appropriates” (sets aside) tax money for the program. Strangely enough, you can’t actually spend money until it’s appropriated. Now historically Congress appropriated money directly for various departments and programs, i.e. they’d pass a “Defense Appropriations Bill” which specifically set aside money for the DoD. But this would then lead to squabbling where, for example, when the Dems were in charge a whomping big appropriation would pass for HUD, but when it came to DoD a whole lot of poisonous stuff for Repubs would be added, and vice versa when Repubs were in charge. So then they started passing “omnibus” budgets that included everything in one fell swoop, so there’d be no more bait and switch tactics. Unfortunately, Congress hasn’t passed a budget in years, principally because the Democratic Senate refuses to do so. So for some years now, we’ve been operating under a “Continuing Resolution,” which is sort of like a half-assed omnibus budget bill, that doesn’t specify much where the money goes, but just shoves it out and says here spend this until we get our shit together. Either way, Congress has given less and less guidance over the years to which expenditures have priority, and which don’t. There have been a number of attempts during the current imbroglio by the House to specify which payments are to be paid first, but the Senate has refused to take up any and all of these, the Democrats attitude being, just write a big blank check or else. So…the bottom line is, Congress hasn’t established any statute that says what the priorities are. That brings us to (3) the Executive, meaning the President, who in principle can decide where to spend the money first, up to a point. There is some existing statute that says the President can’t refuse to spend money if Congress has directed that it should be spent, but this probably isn’t really operative, since we’re talking about a situation where there isn’t money to spend in the first place. Most thoughtful people believe the President has pretty wide latitude to decide where the money gets spent first, and who gets stiffed or has to take an IOU for a while. Most also believe that he will follow the 14th Amendment and see that bondholders get paid, but that after that point he’ll pick priorities so as to maximally embarass his political opponents and put maximum pressure on voters to force them to cave. That is pretty much his prerogative, unless Congress acts first. The final source of authority would be the Supreme Court, and surely if someone isn’t paid the first thing they’ll do is file suit. Then the Supreme Court has to decide whether the Executive’s actions are constitutional or not. Probably as long as the President pays bondholders and SS recipients (who are theoretically paid out of a mythical “trust fund” and therefore in some sense from redemption of government securities, and not from general fund money at all, tee hee), then he’s OK.

What you are observing is a classical balance of terror negotiation between divided branches of government. Who wins isn’t specified by the Constitution, very probably on purpose. The idea is more or less to encourage creativity in how each branch makes its case to the people – the ultimate deciders. If the President is more persuasive in his point of view, the people back him and Congress folds (or gets replaced next year). If Congressional Republicans are more persuasive, the Democrats are routed next year, or even the President gets impeached, and they win. It’s democracy in its rawest possible form, where all that counts is persuasion and who gets persuaded. There isn’t any algorithmical resolution approved by the Founders 230 years ago, and tha’s how it’s supposed to be.

Incidentally, California has “defaulted” like this before. A few years ago they were unable to pay contractors and even income tax returns for a few months, before budget details got squared away, and they gave everyone “vouchers” – IOUs – instead. For the most part, people believed they would be redeemed pretty shortly at full face value, so many banks allowed you to deposit them as if they were a real check.

In principle, the Federal government could do that, too. Just give some contractors and so forth an IOU. It seems quite likely they would be accepted as pretty much as good as cash. Unless, of course, the crisis truly drags on and on. In that case, it could be that the IOUs would start trading at less than face value, as people who needed the cash right now sold them to people with cash, and who could afford to wait longer to get paid. What you would have, amusingly enough, is just an informal version of the Treasury bill. Whether that would breach the debt limit per se is a subtle question of law that I bet lawyers would love to spend $10 million or so arguing in front of the Supreme Court.

What everyone else said.

In addition, even if the Treasury does have a super duper programmer who can put paying off bondholders first, you are still talking about another economic collapse on the order of the one we are still far from having worked out of. This view from afar (it’s from a center-right Indian newspaper columnist) makes sense to me:

There are some other possibilities, some gimmicky, involving the President somehow ordering the limit to be ignored. These would greatly increase presidential power, and, in the long run that’s not good either.

Bottom line: Even if the bondholders are paid, it is still a mess.

I forgot the link for my last post:

I think one problem is that once the US reaches the debt ceiling the Gov’t can’t roll over maturing bonds. The problem is, as I understand it, consider what happens when the Gov’t has a bond come due and the Gov’t is at the debt ceiling. The bond is mature, but it is still a debt. The Gov’t is still at the ceiling. It can’t issue any new bonds to raise the money to pay off the old bond. At some point the incoming revenue won’t be sufficient to clear the old bond. It won’t be able to roll over the debt. Stalemate that will rapidly get worse.

I am afraid those folks who were saying that default won’t be so bad were ill-informed and/or bluffing.