The conventional wisdom is that the debt-ceiling drama is mostly political posturing. Once they've made their point, the thinking goes, Republicans and Democrats arguing over how to rein in out-of-control government spending would reach some kind of agreement, raise the federal debt ceiling, and allow the government to keep functioning normally. But businesses and investors are starting to worry. The government will max out its borrowing ability in early August, and will have to dramatically cut spending if it's not allowed to borrow more. Taxes and other revenue only cover about 60 percent of what the government spends. It borrows--by issuing Treasury securities--to finance the other 40 percent or so. Economists are now running the numbers and trying to predict what will happen if the debt impasse continues and Washington has to stop borrowing. This is not work for the squeamish.
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There's a lot of talk about the government defaulting on its debt, but that's not likely to happen. The government collects about $200 billion per month in taxes and other revenue, and that cash would keep coming in. It borrows another $130 billion or so each month--the money it would have to live without. Interest payments on the nation's debt--which Washington must pay on time to avoid being in default--amount to about $30 billion per month. If forced to choose, the government would almost certainly prioritize debt payments above other obligations, because welching on bonds considered the world's safest would sink financial markets everywhere and make American the world's biggest deadbeat. And the Treasury Dept. would still have adequate cash flow to cover debt payments and remain in good standing with borrowers.
Almost everything else the government pays for, however, would be vulnerable to sudden cutbacks. Here's who would feel the pain most abruptly:
Social Security recipients. The government is due to deliver $23 billion in Social Security payments on August 3, according to forecasting firm IHS Global Insight. If the government is forced to cut 40 percent of its spending, these Social Security checks may not arrive. The suddenness with which the political battle in Washington will hit the wallets of ordinary Americans is one reason many analysts assume that a true impasse over the borrowing limit will be short-lived. But it could still be damaging. Social Security recipients who depend on their checks to pay other bills could end up running behind, incurring costly late fees or damaging their own credit. And it's no guarantee that if stopped, the government's check-writing machinery will start up again without delays or snafus that hold up checks even longer.
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Government employees. Another likely outcome is the shutdown of government offices and the furlough of federal employees. Everyone loves to bash government bureaucrats, but they're a meaningful chunk of the U.S. economy, amounting to 4.4 million workers, including the uniformed military. Many of them will stop getting paychecks, which at a minimum will slow spending and weaken the economy further. That would probably mean the closure of national parks, passport offices, veterans' facilities and many other government offices. Amtrak and the U.S. Postal Service could be affected. The government would probably fence off the military and certain vital services, but even soldiers could be affected if the debt battle drags on.
The unemployed. Washington currently offers extended unemployment benefits to nearly four million people who have exhausted state-level benefits, which last for 26 weeks in most states. Those checks could stop coming, too. One reason unemployment benefits are important is that recipients spend virtually all of the money, providing an immediate boost to the economy. A tighter crunch on the unemployed could also lead to more foreclosures and defaults on other types of consumer debt, since something will have to give if those checks stop arriving.
Investors. Nobody's sure exactly how a sharp cut in federal spending would affect stock and commodity markets--except it would be bad. Federal Reserve Chairman Ben Bernanke told Congress recently that a borrowing moratorium would generate "shock waves through the entire financial system." The U.S. government is the world's biggest spender, and the flow of money from Washington impacts virtually every financial market in the world, through checks sent to thousands of vendors and contractors, the rates paid on Treasury securities, and decisions made by the Federal Reserve. It's almost impossible to predict the daisy chain of events that would unfold as global investors reacted to the sudden upending of the world's financial order.
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But a few general outcomes seem likely. First, a borrowing moratorium of more than a few days might be enough to tip the U.S. and even the global economy into a recession, so banks, employers and foreign governments would suddenly adjust their own spending and prepare for tough times. "Risk" assets like stocks would plunge in value, with safer assets like gold soaring. Investors may flee dollar-denominated assets and search for other safe-haven currencies, though it's hard to tell which ones, since the euro and yen aren't exactly appealing. Some economists worry about a "TARP moment" similar to Sept. 29, 2008, when Congress first voted down the massive bank bailout bill--and the stock market fell about nine percent in a single session. Even if the debt ceiling were lifted after a few days of pandemonium, there could still be lasting damage. "There would be massive dislocation in financial markets, because the recipients of government spending that fail to get priority, and do not get paid, will be unable in turn to meet their own obligations," says economist Nigel Gault of IHS. "Confidence in the ability of the U.S. government to fulfill its most basic responsibilities would be damaged."
Borrowers. Interest rates would go up, but not necessarily soar. U.S. Treasury securities are a baseline investment that anchor the value of many other types of loans, and a sudden risk of default by the Treasury would change that calculus completely. Rates on Treasuries would go higher, to compensate for the increased risk. Many other interest rates would rise in tandem. But other factors would probably keep rates from rising to usurious levels. The Fed would probably act to counter fears of a recession. A recession itself, if one occurred, would weaken demand for credit, which usually pushes rates down. And investors would bid on bonds while expecting an eventual solution from Washington, which means a rate hike could be temporary. Even that, however, could play havoc with global portfolios.
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The government itself. Any moved that weakened the economy and threw more people out of work--or simply impeded hiring--would further reduce the government's tax revenues and make the U.S. debt problem worse.
Art lovers, beachgoers, and public TV viewers. A long list of "discretionary" federal programs has been targeted for cuts or elimination, and those could end up getting whacked right away. These tend to be low-visibility programs that don't cost all that much--compared to huge budget items like Medicare or military spending--but fund nice-to-have things that many people would miss if they disappeared. Earlier this year, House Republicans outlined dozens of cuts they'd like to see in things like the National Endowment for the Arts, the National Endowment for the Humanities, the Corporation for Public Broadcasting, beach replenishment, grants for intercity rail service, regional development agencies, and local transit.
If cut, those programs could see funding restored once the crisis passes. But if the big spending cuts happen, Americans will notice that a lot of things they don't necessarily associate with Washington are suddenly unavailable. The federal government is big, indeed. We may be about to find out just how big.
Twitter: @rickjnewman
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