Defaulting on US Debt Dangerous to Even Consider, Say Experts

Washington – Congress is playing a game of “chicken” with the nation's finances, and the U.S. economy is at stake, with an Aug. 2 deadline.

The gross federal debt hit $14.3 trillion on May 16. That's as high as the law allows. Unless Congress raises the legal ceiling to permit more federal borrowing, a financial disaster is all too possible.

Treasury Secretary Timothy Geithner has said he can juggle accounts until Aug. 2, but no longer. Then the U.S. may default on its debt, something that experts agree should be unthinkable, because it could cause enormous financial damage worldwide.

Congressional leaders of both parties acknowledge this and say they won't let it happen. But Republicans are holding the increase in the debt's ceiling hostage to Democratic agreement to cut $2 trillion from federal spending over the next 10 years. Negotiations to do that are slogging along behind closed doors. Meanwhile, experts warn that delay is increasingly risky.

On May 20, Prince Alwaleed bin Talal, the Saudi investment mogul, warned on CNBC that “the United States is not giving much care and attention to this time bomb that you have right now here.”

The dollar is the world's favored reserve currency. Treasury debt long has been considered the safest investment in the world. The very suggestion that the U.S. might default on its debt raises a host of unknowns.

“We don't know how this would work out, because it's never happened,” said Nigel Gault, the chief U.S. economist for forecaster IHS Global Insight.

Congress has raised the debt ceiling 10 times since 2001. Geithner, Federal Reserve Chairman Ben Bernanke and virtually every prominent economist are warning that failing to raise it now could be catastrophic.

Here's what's all too possible:

A default would mean that Washington would stop paying interest to those who own government bonds. Credit markets could seize up. Stock markets could plummet. The recession could come roaring back into our lives.

Bond rating agencies would downgrade the U.S. AAA credit rating; Standard & Poor's already put it on a negative outlook status on April 18. That would mean the U.S. government is seen as less creditworthy.

Interest rates would rise across the economy, not just for government bonds but also for corporate bonds and consumer loans to buy homes, cars, everything.

“You'd clearly see substantially higher interest rates, and this flows through as the markets seize up. … People wouldn't be sure whether anyone else's collateral is any good,” Gault said.

The near-crash of the U.S. financial system in 2008 taught us that once credit markets begin to seize up, the extension of virtually all credit follows suit. Companies can't roll over their debt. Even plain-vanilla investments such as money market funds are suddenly stricken.

Since 40 cents out of every dollar the government spends now comes from borrowing, and the government then could spend only what it took in, federal spending would fall by 40 percent.

What spending would be cut? Soldiers' pay? Social Security benefits?

That's not to say that Washington doesn't have to stop piling on debt. Government debt held by the public has doubled over the past four years. In 2008, it was $5.8 trillion. For the fiscal year that starts Oct. 1, it's projected to be $11.8 trillion. This excludes debt the government owes itself — borrowed from trust funds such as Social Security's — which brings the gross federal debt total today to $14.3 trillion.

If current law remains unchanged, debt held by the public will grow steadily to peak at $18.2 trillion in 2021, the nonpartisan Congressional Budget Office projects.

Simply paying interest to the bondholders of all that debt will cost about $242 billion next year, according to the White House Office of Management and Budget. It'll more than double to $562 billion by 2016, the OMB estimates.

So experts agree that Washington needs to arrest its debt addiction by changing spending and tax policies. But they also agree that it needs to raise its debt limit first, independent of that, to avoid possible financial chaos.

“The rest of the world, where a lot of the investors are, doesn't understand American politics, and is completely baffled by the idea that we might deliberately provoke a debt default,” said Alan Blinder, a former vice chairman of the Federal Reserve.

If it seems implausible that Congress could fail to raise the debt ceiling given the possible consequences of not doing so, remember this date: Sept. 29, 2008.

That's when Republicans in the House of Representatives defied their president and defeated a bank bailout bill, shocking financial markets. The Dow Jones Industrial Average fell almost 800 points, the largest one-day point drop ever.

Although Congress later reversed itself, historical financial data shows that this was the inflection point that sharply deepened the financial crisis and intensified the Great Recession.

Now fast-forward to this May 17. House Budget Committee Chairman Paul Ryan, R-Wis., told CNBC television that “lots” of Wall Street players weren't worried about a debt default so long as it lasted just a few days.

“I think most people think that's nuts,” Gault said.

In a May 20 research report, economists at Bank of America Merrill Lynch warned that a manufactured debt crisis would “undermine long-run fiscal stability, both directly and through psychological effects on investors. We continue to see the debt limit as a poor tool to force fiscal discipline.”

Blinder fears that the government is already close to hurting itself even if default is avoided.

“If it gets threatened now and it goes to the brink like the recent (near) government shutdown … then I think you start to establish a precedent, that when we have divided government this becomes a tool in the kit of a minority party” said Blinder, who's now a Princeton University economist.

Then we could go through this threat again and again.

© 2011 McClatchy-Tribune Information Services

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