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.