What would happen if Congress lets the United States government default?
The word we keep hearing is
“A US Default Seen as Catastrophe, Dwarfing Lehman’s Fall,” screams the headline in Bloomberg Businessweek. “A default would be unprecedented and has the potential to be catastrophic,” says a Treasury Department report issued on Thursday—two weeks before the government is expected to begin running out of cash.
But what does “catastrophic” actually mean in this context? In the summer of 2011, when Republicans refused to raise the debt ceiling unless President Obama caved to their extortionist demands, the same word was bandied about. It scared the political class enough that they kicked the can and avoided a default.
This time around, the need to raise the debt ceiling doesn’t seem to be generating nearly the same concern. Indeed, Tea Party Republicans seem to be almost rooting for the government to default, as if that would somehow bring about the smaller government they so yearn for.
But this is incredibly wrongheaded. A failure to raise the debt ceiling, should it come to that, would likely inflict a different kind of pain than sequestration or even a shutdown of the federal government. It won’t make the government smaller. But it does have the potential to diminish the value of one of America’s greatest assets—the backing of its debt—while throwing the world economy into chaos.
The first point worth making is that the 14th Amendment to the Constitution, which declares that “the validity of the public debt of the United States … shall not be questioned,” was added precisely to avoid what is happening now: a faction of Congress using the debt ceiling as a bargaining chip. That basic truth, as Fortune’s Roger Parloff noted in a recent blog
post, “ought to weigh very heavily in the minds—
and on the consciences—of the House Republican faction that is now unambiguously violating its letter and spirit.”
The second point worth making is that US government debt is the only risk-free asset in the world. That debt undergirds the entire world financial system—precisely because the whole world has such faith in it. There is always demand for US government debt. Almost every other asset you can think of is in some way measured against it. A default would destabilise the market for Treasuries. And that, in turn, would likely destabilise every other asset.
The stock market would fall.
Interest rates would rise—meaning, for instance, mortgages would