Photo: Flickr/Julian Povey
The word “default” gets thrown around a lot in the media, and it’s also used by The White House to describe what will happen if the GOP doesn’t raise the debt ceiling.But this term remains controversial.
Some argue that default should be specifically used to mean a literal default on US debt… not making an interest payment on time.
Others argue that a default, even on Social Security, is a default. And they argue that missing a Social Security, in addition to being an economic calamity, would also have credit implications, because if you’re a lender to the US, and you see the US missing major payments, then that tells you something big about the US’ creditworthiness.
This view was promulgated by Tim Geithner, back in 2011, when he sent a letter to Pennsylvania Senator Pat Toomey, on why “prioritization’ was unworkable:
As I also explained, however, the Treasury Department has reviewed your legislation and determined that it is unworkable and would not achieve your stated objective of protecting U.S. creditworthiness. In fact, the legislation would be quite harmful if enacted. A simple analogy may help illustrate the problem. A homeowner could decide to “prioritise” and continue paying monthly mortgage payments, while opting to cease paying other obligations, such as car payments, insurance premiums, student loan and credit card payments, utilities, and so forth. Although the mortgage would be paid, the damage to that homeowner’s creditworthiness would be severe.
Almost every time you analogize the US economy to a household, you run into trouble, and here Geithner’s view is problematic for two reasons.
For one thing, US debt doesn’t trade like a “credit” (an entity for whom interest rates reflect risk of non-payment). US rates are about growth, inflation, etc. That’s why, even though everyone and their cousin talks about how “unsustainable” US spending is, interest rates on US debt haven’t gone up. And most likely, in a “prioritzation” government shutdown, there would be a rush into Treasuries, as growth would collapse.
But beyond that, you have to appreciate the unique role that Treasuries play in the financial system. Treasuries are basically the definition of safe asset. Numerous regulations for all kinds of entities all around the world are premised around “safe” behaviour having money int Treasuries. There is no asset that has anywhere near the size, liquidity, and safety as US Treasuries. If you break that (by having the Treasury briefly miss an interest payment) you’ve basically sent the financial system in the 9th Circle Of Hell. Nobody has any idea what would happen.
Missing Social Security? Yeah, that would be bad. Missing a bond payment. You’ve basically lit a massive fire, and in the extreme heat, you’ve evaporated the liquidity from the financial system. It’s a huge difference, and it’s extremely useful to distinguish.
Of course, even in a “prioritization” you could have a debt default, because tax revenue and income payments are lumpy, and the Treasury could straight up run out of money to make a bond payment. So this isn’t too be cavalier about breaching the debt ceiling. It’s just a plea to use language in the most useful way possible.
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