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 per cent of GDP every year (and that has borrowed nearly 100 per cent 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?
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