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Treasury Default?

Wednesday June 1st, 2011   •   Posted by Emily Skarbek at 9:12am PDT   •  

The Treasury Department reiterated that Aug. 2 remains the projected day the U.S. would start defaulting on its obligations.

The U.S. reached its $14.3-trillion debt ceiling on May 16, but Treasury officials have been doing some complex financial juggling to push off the date at which the nation would start defaulting on its obligations. Treasury Secretary Timothy F. Geithner has said those “extraordinary measures” could only postpone the fiscal reckoning for several weeks.

Professor Jeff Hummel has long argued that Treasury default is highly likely. So today’s news perhaps comes as no surprise. Last week, Alan Blinder provided an eye opening remark:

What happens if we crash into the debt ceiling? Nobody really knows, but it’s not likely to be pretty. Inflows and outflows of cash to and from the Treasury jump around from day to day as bills are paid and revenues arrive. But at average fiscal 2011 rates, receipts cover only about 60% of expenditures. So if we hit the borrowing wall traveling at full speed, the U.S. government’s total outlays—a complex amalgam that includes everything from Social Security benefits to soldiers’ pay to interest on the national debt—will have to drop by about 40% immediately.

If gridlock could push us into scaling back government expenditures by 40% I would be elated. But if you thought Government officials had a plan on how to prioritize the bills. Blinder’s comments should make you think twice.

How in the world do you do that? No one really knows. If and when the time comes, Mr. Geithner and his boss will have to decide. But here’s one prediction: Defaulting on the national debt will not be their first choice. After all, the statue of Alexander Hamilton at the Treasury entrance reminds Mr. Geithner every day of the importance of maintaining the nation’s creditworthiness. Even if we hit the debt ceiling, maturing obligations still can be rolled over. And I’ll bet he will bend every effort to make the interest payments, too. Unfortunately, however, when you’re 40% short, not much can be ruled out.

The bills for Social Security, Medicare, Medicaid, national defense and interest on the debt comprise about two-thirds of all federal outlays. So they can’t all be sacrosanct indefinitely. At some point, Mr. Geithner could wind up brooding over horrible questions like these: Do we stop issuing checks for Social Security benefits, or for soldiers’ pay, or for interest payments to the Chinese government? Such agonizing choices are what make default imaginable.

One option? Repudiate the debt. Hummel argues the moral case for debt repudiation but also discusses particularly interesting economic consequences.

*Fun fact: Hummel wrote this piece in 1981, the year I was born. At that time, total federal debt was approximately $1 trillion dollars. This year, annual budget shortfalls are projected to top $1 trillion.

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June 2011