Why would the federal government necessarily default on bond payments if the debt ceiling is not raised?

Implicit in a lot of news reports about the impending August 2nd debt limit deadline is that if the debt ceiling is not raised, the federal government must necessarily default on payments to bondholders. Default would be bad mostly because it would likely raise interest rates in the future and a country that insists on borrowing 10 percent of GDP every year (and that has borrowed nearly 100 percent of GDP already, with the intention of never paying it back but simply rolling it over into new debt) should want to keep interest rates low.

Where is it written that the government must default on August 2nd if it can’t borrow more money to pay interest on the money that it has already borrowed on our behalf? What would stop the federal government from, at least temporarily, spending no more than it takes in? The U.S. government is sovereign. Nothing requires the federal government to write checks in the amounts that are currently being written. It could start paying federal workers less, reduce Social Security and Medicare benefits, lay off workers and soldiers, withdraw from our adventures in Libya, Iraq, and Afghanistan (we can always start a new war later if we need to), give up on the war on drugs, stop paying for 99 weeks of unemployment, stop meddling in K-12 education, etc.

Are there are any examples of governments spending within their means? It wasn’t easy to find too many with a Google search! Switzerland has a balanced federal budget as part of its constitution (source; IMF paper). We can infer that the countries with low public debt relative to GDP have historically been living within their means (see http://en.wikipedia.org/wiki/List_of_countries_by_public_debt; Chile is a good example). So it can be done.

Suppose that Americans don’t like the result of a federal government that has been shrunk down to match its revenues? Then they will be more inclined to accept new taxes. Given the $14 trillion in debt that we will need to refinance (clock), there would be nothing worse than a default with consequent higher interest rates. Why then do we assume that when we hit our debt limit we should automatically give priority to continued spending rather than paying what we promised to bondholders?

34 thoughts on “Why would the federal government necessarily default on bond payments if the debt ceiling is not raised?

  1. True. There is more than enough money to send out the 70 million checks Obama mentioned on CBS a few weeks ago…before he proceeded to demagogue the nation with Social Security Scare tactics. Ummm, what about the SS Trust fund?

    The debt is mainly owed to US banks and entities such as social security, not foreign nations.


    Interest rates are a direct function of credit worthiness, i.e. Probability of default. Our creditors won’t likely be demanding higher interest rates because the US can never default – we can always print money to pay back, e.g., the SS Trust fund. It’s all theater…

    Also doesn’t it remind you of the TARP bailout? Give banks $787B in September 2008 and this will prevent total collapse of the economy and stock market. What happened? Well, banks did well. Fannie and Freddie did well, as did AIG, Goldman Sachs, and other too big to fails. But what about the stock Market … It collapsed to Dow 6600 in March, six months later. And that was even after bailing out the auto industry as well.

    Fast forward 3 years and unemployment is nearly 10%, Obama and congress have increased the national debt more than Bush with failed stimulus. Another huge entitlement program looms (Obamacare), Dodd Frank has been an utter failure…

    Seems eerily similar to an earlier movie…

  2. Indeed. Congratulations for being one of six people who seem to understand this!

    I’ve stopped bothering to write letters to editors — of publications such as the Wall Street Journal, who surely know that what they publish is inaccurate — trying to separate the issue of the debt ceiling from that of default.

    The federal government, as you correctly note, takes in way, WAY more than it needs to pay interest on the debt. Indeed, it seems most people agree that the 14th amendment prohibits a voluntary default, so we should expect those payments to be made, whether or not we can borrow more (not that our government seems to care overmuch what the constitution may or may not say).

    Failing to raise the debt ceiling would simply be a balanced budget amendment. Better than that, even, because all such amendments I’ve ever seen naturally give Congress the choice to ignore it in “extraordinary” circumstances (undefined, but presumably including perpetual war).

    I can frankly think of no better thing.

    Sadly, I’m sure that “bipartisanship” will carry the day, to ensure the ponzi scheme can continue just a little while longer…

  3. David: The Atlantic article that you cite says it would be difficult for the government to operate a lot of functions that we expect if it paid 100% of what it is currently paying for “debt service, military payrolls, Social Security, Medicare, and Medicaid”. My point in the original posting was precisely that, rather than default, the government could decide that it is NOT going to pay for the military, Social Security, Medicare, and Medicaid at current levels.

    A lot of the programs that are mentioned in the Atlantic article could be cut significantly rather than eliminated. For example, the Atlantic author scares folks with the thought of federal prisons being shut down entirely and the inmates released. But what if we gave up on the war on drugs and released the non-violent drug offenders? Other programs mentioned in the Atlantic are primarily state programs, e.g., unemployment insurance and K-12 education.

  4. Brian – “Our creditors won’t likely be demanding higher interest rates because the US can never default – we can always print money to pay back”

    Printing more dollars devalues all dollars. You’re kidding yourself if you think creditors don’t know this and won’t respond either by raising interest rates or halting all lending once they start to believe this is how they will be paid back. Not to mention the utter economic destruction which would be brought on by an attempt to print away the deficits and debt. Saudi oil sheiks and Chinese factory owners aren’t fooled by such games. If you devalue the dollar by half overnight, prices will double overnight, a good way to get the middle class to violently revolt.

    philg – the reason the government is not seriously considering reducing spending levels is because our politicians are slaves to special interests. No Senator or House Representative would survive voting for cuts to Social Security, Medicare, the drug war, the never ending war on terror, etc. I don’t know how the U.S. is going to get out of the mess it’s in short of being forced to change by a hard economic collapse, something much worse than what we’re going through. I don’t want to have to live through it, but I think the U.S. actually needs its creditors to stop lending. We need Congress and the President to wake up one morning and realize they have no choice but to slash the Federal government because the money is simply no longer there.

    You don’t give a shopping addict more credit cards. You cut the credit cards the addict has into pieces.

  5. And what legal basis is there for not spending the money that Congress appropriated? What makes the (arguably unconstitutional) debt ceiling law more lawful than the approbriation laws?

    What would happen if Obama and Geithner simply decided to keep writing all the checks the Federal government is obligated by previous legislation to write? You think Bernanke would bounce a US Treasury check presented to the Fed?

  6. Ray: Technically true, although finding buyers to fund a rollover doesn’t seem to be a problem right now.

    Indeed, under our current system of Primary Dealers, it’s technically impossible to have a bond auction failure. Whatever they can’t sell, the Primary Dealers will soak up.

    philg: Indeed, not only could we decide not to pay for all of those things, let’s be honest: it is mathematically impossible to pay for all of those things.

    Government spending cannot grow faster than GDP on a sustained basis. Eventually, exponents catch up with you (we could ask the PIIGS how that turns out).

    The sooner we admit that politicians of the last 30 years have written checks that the US taxpayer can’t honour, the better off we all are.

  7. The Department of the Treasury apparently has a plan to prioritize payments, with bondholders first in line:


    However, they argue that the budget is a contract, written by Congress and signed by the President, that creates obligations that are as capable of being in default as is bondholder debt:


    I suppose it’s like making payments on the mortgage, student loan, credit card, etc., while balking on cable TV and cell phone service, despite being locked into one-year contracts for those. Depending on early termination policies, this may have the effect of wrecking your creditworthiness.

    Of course, even if you agree with that, we’d be in a Red Queen’s race of taking on new debt to pay off old debt, which I would agree is lunacy in the long term. But that’s a topic for another post. 🙂

  8. The enlightenment comes when you realize that all the money issued in whatever fashion has interest attached to it. So default will always happen at some point in time due to compund interest.

  9. Quoting from James Surowiecki at the New Yorker (http://www.newyorker.com/talk/financial/2011/08/01/110801ta_talk_surowiecki) (via http://www.calculatedriskblog.com), “The only reason we need to lift the debt ceiling, after all, is to pay for spending that Congress has already authorized.”

    My initial thought is that I would be uncomfortable with the idea of our federal government being able to decide, on a whim, to pay less than it had originally agreed to. In the most significant cases you mentioned (Social Security, Medicare, Medicaid), the payments are written into law.

    So yes, our federal government is a sovereign entity, but I would prefer it not break its own laws so blatantly. Rule of law is one of the more important cornerstones of our brand of democracy.

  10. Why is the debate dishonest, with the implied threat that if the government not get higher spending authority, it will shoot itself and all of us in the foot?

    Why do state governments always pick the most menacing solutions when they don’t get enough money, by reducing the number of school days, and closing state parks.

    The Reagan analogy between between a baby and the government applies:


    and by throwing such tantrums, the state and local governments confirm Reagan’s analogy.

  11. It’s not just the risk of default. The effect on the US economy itself will be dire:

    Konrad Yakabuski, writing in the Toronto Globe and Mail: Debt-ceiling deniers court economic disaster.

    An analysis by [Jay] Powell, a visiting scholar at the Washington-based Bipartisan Policy Center, shows that the U.S. government is projected to take in $172-billion in revenues between Aug. 3 and Aug. 31, but face bills totalling $306-billion.

    The shortfall of $134-billion would not only force the government to choose whom to pay among its millions of debt holders, pension recipients and employees. The sudden plunge in federal spending – equivalent to a staggering 10 per cent of U.S. gross domestic product in August – would by all accounts pull the rug out from under the economy.

  12. Treasury has acknowledged — with crystal clarity, from their chief lawyer — that the debt ceiling is completely constitutional, and trumps appropriations: http://www.treasury.gov/connect/blog/Pages/FACT-CHECK-Treasury-General-Counsel-George-Madison-Responds-to-New-York-Times-Op-Ed-on-14th-Amendment.aspx

    And ultimately it doesn’t matter. Neither the most impassioned Communist’s, nor the most hard-line budget hawk’s: what cannot be paid will not be paid. We can argue about not cutting entitlements until we fall over dead; the money simply is not there. Sometimes governing means making choices. We’ve tried to avoid making choices for 30 years — perpetual war and free health care and ponzi retirement schemes and bank bailouts and … and now the chickens are coming home to roost.

    You can’t grow entitlements at 7% a year while the economy grows at 4%, which we’ve been doing for 30 years. Exponents are a bitch that way.

  13. “And what legal basis is there for not spending the money that Congress appropriated? What makes the (arguably unconstitutional) debt ceiling law more lawful than the approbriation laws?”

    Simple. Laws passed by Congress, to the extent that they conflict with prior law, override prior law.

  14. philg,

    My point in the original posting was precisely that, rather than default, the government could decide that it is NOT going to pay for the military, Social Security, Medicare, and Medicaid at current levels”.

    How would that work in practice? Would Tim Geithner decide which military programs to de-fund, which states did not receive aid dollars, and how to balance cuts across Medicare, Medicaid and Social Security? In doing so, has he not assumed a power not granted him by the Constitution? Also, servicing bond debt is just one kind of legal obligation that binds the executive branch. The executive is charged with executing all the laws passed by congress and is expected to honor any contracts it has entered. Much government spending is in the form of contracts with private companies. Again, does Tim Geithner get to choose which laws he will ignore and which contracts he will break?

    That being said, I have never read anything in which someone from the administration has suggested that bond holders are near the front of the line for being stiffed.

  15. Russil: Agreed that balancing the federal budget would cut 10 percent off the stated GDP numbers. However, there would still be roughly the same number of Americans doing roughly the same stuff. Nearly the same number of people would be producing goods in factories. Nearly the same number of people would be farming (maybe not quite as many in the cornfields if the government stopped paying out ethanol subsidies). Nearly the same number of people would be relaxing in retirement. As noted in http://philip.greenspun.com/blog/2011/06/16/revitalizing-the-u-s-economy-through-government-spending/ , a lot of what the federal government does contributes to GDP only in the same technical sense that breaking windows and replacing them contributes.

    If we think that the 10 percent of GDP that comes from extra federal spending is good, then running a larger deficit would be even better. We could grow the economy by 10 percent at the stroke of a pen, e.g., by making every government check larger. A procedure for which Medicare currently pays $3000 would now pay $6000. Economists would celebrate our robust GDP growth.

  16. PhilG wrote:
    Are there are any examples of governments spending within their means? It wasn’t easy to find too many with a Google search!

    The United States in 2000. Didn’t we run a surplus with plans to totally pay off debt by 2010 or 2011?

    I get a sense that the anti-tax / small government people would argue that you never want spending within the means since that would remove a pressure point for cutting spending.

  17. Christopher: I’ve read that the (unexpected) U.S. surplus in the late 1990s/early 2000s was mostly due to the stock market bubble of the time and the consequent huge increase in capital gains taxes and some other taxes. The increases in revenue were far larger than the increases in GDP so there was no way that it would have been sustainable. The surplus was basically an accident (though perhaps this is most easily perceived in hindsight).

  18. Philip: there’s going to be a lot more people unemployed. Once government spending drops by 10% of GDP, a lot of businesses are going to see their revenues drop, and they’ll need to cut their spending to stay in business: in other words, they’re going to be laying people off. The newly unemployed will need to cut their spending as well. And so on. The economy’s going to shrink.

    You can’t run a deficit forever, of course. When the economy’s doing well, you need to run surpluses and pay down the debt, by raising taxes and cutting spending. (This is what Canada did to balance its budget in the mid-1990s: the federal government brought in a value-added tax, the GST, and cut spending and provincial transfers by about 20%.)

    But cutting taxes during a boom (the $1.3 trillion Bush tax cuts), and then cutting spending in the middle of a deep recession, is crazy. I don’t know what to say. It’s like watching the US shoot itself in the head.

  19. Russil: I don’t think the employment ratio that you cite is evidence that we are in a deep recession (supposedly the U.S. recession ended in mid-2009). As noted in http://philip.greenspun.com/blog/2010/08/08/unemployed-21st-century-draft-horse/ it may simply be that a smaller percentage of American workers are profitable for a company to hire under prevailing conditions (tax, law, complexity of processes, etc.). Given that the quality of our high school and college graduates stagnates or declines and the complexity of work goes up, one would expect the percentage of employed Americans to decline every year going forward.

  20. Christopher Cilley: that surplus was only a surplus by the strange definitions of a politician.

    As every administration (Republican and Democrat alike) has done for at least 20 years, that surplus was achieved by stealing Social Security and Medicare receipts that should have gone into the “trust funds”.

    Instead they put debt into the funds, but intragovernmental debt that isn’t directly marketable (ie, can only be sold back to Treasury) and thus (?) doesn’t count against the deficit. It’s an artful bit of bookkeeping that would get you or I put in prison if we did it in a private company.

    This is why the trust funds are a complete farce, why Al Gore’s lockbox was such an absurd concept.

    The 2000-era surplus was a mirage, an accounting sleight-of-hand, in addition to the Internet bubble factors that philg mentioned.

  21. I love Phil’s take on this, and if I could vote for it I might. I would certainly vote for it based on how Phil sells it. My problem is the politics. According to Douglas Holtz Eakin, if we go with Phil’s plan then President Obama makes all the decisions on what gets spent and what doesn’t. Obviously, Obama will only spend money on areas that help Democrats in the elections, and wherever he rolls back spending he’ll have the bully pulpit to blame Republicans. Okay, so far, Phil’s plan still sounds good. We still get real spending rollback. But then what? With the power and therefore the politics so favoring the Democrats in this scenario, they win the election in sufficient numbers just to go back to massively increasing the debt.

    To tell you the truth I’d still vote for Phil’s plan, but only for two reasons:

    1) Curiosity about what will happen next, and
    2) I don’t believe there is any way out of this mess without a historic reckoning that is going to change everything the world over. Might as well get on with it.
    3) Who knows? If there is a way out of this mess it’ll only be through something like Phil’s suggesting.

  22. Douglas: Thanks for the vote of confidence! I don’t think a one-party government is a bad thing when a state or country runs out of money. It enables cuts to be made without politicians saying “We wouldn’t have to do this except for that other party that is obstructing everything”. Massachusetts (a one-party state), for example, recently trimmed back some public employee union benefits without the protests, etc., that attended such cuts in states where two parties have significant voices. The unions complained, of course, and would have liked to collect additional taxpayer dollars for their members, but the Democrats running the state simply said “sorry but we are out of money” rather than “we will give you a lot more in exchange for your support against the Republicans in the next election”.

    And now that you mention it, maybe hitting the wall financially is the only way out of Iraq, Afghanistan, and Libya. A politician can say “we are quitting this war tomorrow because we’re out of money” without the appearance of weakness that would come from “we are quitting this war tomorrow because we have lost”.

  23. Phil,

    But of course one-party Massachusetts would not have trimmed back public employee union benefits if they just had the option to print more money. Washington can do that, and it will (sooner or later). What’s really upsetting is that if we have 1-party rule by the Republicans they would continue printing new money as well, they’d just spend less than the Dems want to spend.

    Ironically, it’s only two-party gridlock that can give us the outcome you’re talking about. The tricky part is sustaining that.

  24. According to this article, we have about $500 billion of debt maturing in August.

    The very nature of some debt maturing is that we can get new debt to replace it. The US’s short-term borrowing costs are, right now, very low. Although that could change suddenly.

    Our creditors won’t likely be demanding higher interest rates because the US can never default – we can always print money to pay back,

    The Fed prints the dollars, not the Treasury. (Although the Treasury may be able to mint new coins.) Also, printing money increases inflation, and our creditors will demand more interest.

    And what legal basis is there for not spending the money that Congress appropriated? What makes the (arguably unconstitutional) debt ceiling law more lawful than the approbriation laws?

    The only argument for a debt ceiling being unconstitutional would be if it was stopping us from meeting the Fourteenth Amendment. The US not being able to spend all the money it wanted to spend isn’t anything like defaulting on the public debt.

    However, they argue that the budget is a contract

    I searched that PDF for “contract” and couldn’t find it. Please specify. But I’m not too impressed because they say it’s a “myth” that raising the debt ceiling increases the Federal government’s obligations. It might be a good idea to raise it (I think it is), but that doesn’t mean it’s not increasing the government’s obligations.

    My initial thought is that I would be uncomfortable with the idea of our federal government being able to decide, on a whim, to pay less than it had originally agreed to

    Congress can change your SS payments at will.

    In doing so, has he not assumed a power not granted him by the Constitution?

    He might. But the Executive Branch borrowing on its own is definitely against the Constitution; that is explicitly the domain of Congress. We could be facing a Constitutional Crisis where nothing the Executive does is legal.

    All that said, as Russil Wvong says, a sudden vanishing of about one-sixth of the economy would be pretty bad. And the cuts wouldn’t last. What will happen is that citizens will miss all the old government services disappearing all at once, and vote the Republicans out. The Democrats will have a super-majority and (in their eyes) a mandate to increase borrowing and spending.

  25. no one has mentioned that Federal taxation of corporations & the richest tax bracket are at historical lows, in terms of the percentage of the total tax pie that they pay.

    During Eisenhower, for every $1.00 the income tax, there was $1.50 in corporate tax.

    Now the corporations pay $0.25 for every $1 in income tax.

    The US is something like 22 of 24 in the lowest corporation tax of the OECD. US Corporate Whore PR hacks claim about high US tax rates, but the huge loopholes & corporate welfare tax breaks make the actual taxes paid by corporations minimal.

    Not to mention the corporate welfare for cartel special interests where the US pays 50-100%+ more than any other OECD nations: health care (insurance, pharma, physicians, etc), military industrial complex, Wall $treet banksters, Oil, excessive IP laws (example – Micro$oft monopoly) etc.

    I’d like to see the NPV from 2011-2085 of all the corporate welfare associated with maintaining these Conservative Nanny State (c) Dr. Dean Baker, cartel welfare policies, using the 2nd expensive or median OECD cost per GDP of these industries as a comparison.

    No one does that calculation. But the plutocrat party (Obama & Boehner) is always harping on the NPV of the next 75 years of SS & Medicare.

    It would be nice if actual small biz that work in an actually competitive market or against an existing cartel market, would lobby against the cartels. Eg presumably like the businesses Philg started. I don’t want to see any corporate welfare, but if it “has to exist”, I’d like to see it directed towards these non-cartel, actually entrepreneurial companies.

  26. Taxing corporations is taxing people. You can either tax their profits when the corporation earns them, or when the shareholder earns them

    In fact, if you biggest gripe is with “the rich,” you would want to cut the corporate tax to 0% and tax capital gains and dividends like normal wages. Because then $1 of profit allocated to the poor crippled granny would be taxed at 10% and the $1 of profit allocated to the greedy plastic surgeon doctor would be taxed at 35%.

  27. El Gringo: there’s pragmatic reasons for shifting taxation from corporate tax to income tax. Capital is more mobile than labor. Even here in Canada, economists are generally agreed that lowering corporate tax rates makes sense, and corporate tax rates have been steadily lowered over the last decade or so.

    It’s true that the US tax system isn’t very progressive, especially since the Bush tax cuts lowered the capital gains tax rate from 28% to 15%. In 2007, the average effective income tax rate for the top 400 taxpayers (average income: $345 million) was only 17%, even though the top tax rate on regular income is 35%. (Associated Press.)

    Dan: it’s 10% of GDP, actually (which is still huge, of course). There’s news stories about troops in Afghanistan asking if they’re going to get paid. I never expected to see the US turn into post-Soviet Russia.

    I think the source of the deadlock is that the Republicans and the Democrats represent two views which may be irreconcilable.

    One view is that government is a huge waste, and government spending should be as close to zero as possible. Let’s call it the anti-government faction.

    The other view (the status quo faction) is that government is a critical part of society as it exists today, providing the traditional functions of war, diplomacy, and justice; dampening the wild swings of the business cycle; and helping to close the gap between rich and poor, by funding services like public education and health care through a tax system which falls more heavily on the rich than the poor. (It’s not difficult to have a society where the rich live in extravagant luxury and the poor struggle to keep from starving; see any ancient empire or modern Third World country. It’s far more difficult to maintain a middle-class society of broadly shared prosperity.)

    The only common ground here is that the status quo faction is willing to look for spending cuts, to make the government more efficient. I don’t think it’s going to be enough for the anti-government faction. And it’s going to make the recession worse. (Philip, I know you don’t believe there’s a recession.)

  28. Note how when the debt ceiling deal was finally signed our credit rating didn’t change and the stock market crashed anyway. Again, as i said earlier, eerily similar to 2008 TARP sound and fury, changing nothing.

  29. Bloomberg article on how investors are anticipating that the agreed-upon spending cuts will further weaken the economy.

    In choosing austerity, the U.S. is embarking on a course that some European nations already have pursued with mixed results. A new coalition government in the United Kingdom last year enacted a program of reduced spending and tax increases aimed at closing the budget deficit.

    … In the second quarter, the U.K. economy grew 0.2 percent from the previous quarter. That left total output barely above the level reached in the third quarter last year.

    “The economy is at stall speed even before the public expenditure reduction starts to kick in,” Magnus said. “The omens for this in the U.S. are really poor. The situation is quite comparable.”

  30. Note how when the debt ceiling deal was finally signed our credit rating didn’t change

    Should it have?

    The spending cuts from the budget deal over the next year are so vanishingly small it’s hard to imagine that you could even detect the drop in the GDP from them.

    And, seriously, the budget problems aren’t from having occasional periods like 2008-2011. It’s from the huge growth in entitlement spending, which is happening in the long term. Cuts for the future are fine.

  31. “Should it have?”


    “The rating agencies have been clear enough in their warnings that bond investors such as Pimco Executive Vice President Mark McCray give a downgrade on Treasurys a 50-50 chance, even if the debt ceiling is extended by the necessary date.

    There are no cuts aside from ~$100B in the next 12 months. The current congress can’t bind a future congress to cut the debt. This just passes the buck to future election campaigns.

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