What Happens if the Government Defaults?

No one knows exactly what would happen, but it won’t be pretty: A Dispatch Explainer.

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A screen shows the national debt clock after the US hit its debt limit and the Treasury started using "extraordinary measures" to avoid default on January 19. (Photo by Fatih Aktas/Anadolu Agency via Getty Images)

Economists still don’t know the full consequences of failing to raise the debt ceiling before the U.S. Treasury’s “extraordinary measures” are exhausted this summer. Though most broadly agree with Treasury Secretary Janet Yellen, who said this week that defaulting on the national debt would be a “catastrophe.”

Not raising the debt ceiling also means the federal government will have to break the law somehow: Borrowing beyond the limit set by Congress (most recently in 2021) is blatantly illegal—but so is refusing to spend money Congress has appropriated.

What are other consequences of failing to raise the debt ceiling? 

Less money in means less money going out.

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  1. Jfan

    I am reminded of a custom which some Jews follow at Passover: Rather than getting rid of all their unleavened bread, or to cover any unleavened bread which they may have missed, they "sell" the unleavened bread in their house to a non-Jew in a supposedly legally binding contract, which also includes a buy-back provision following the holiday. I wonder whether the government could do this with some of its gold reserves.

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  2. CatoTheElder

    Anyone who predicts with any sort of confidence what will happen in the face of a U.S. default on debt is, I believe, betraying their lack of knowledge about a lot of things, including their lack of knowledge about a lot of things.

    The U.S. is the $23 trillion dollar gorilla in the world's economic forest, with the second-largest gorilla being China, not even close to the same weight class, coming in at $14 trillion. No other nation is anywhere close to the Chinese, forget about the U.S.

    The U.S. economy is plodding along with a $32 trillion dollar albatross hanging around its neck. That albatross is growing, and in order to keep carrying it, the U.S. has to keep growing its economy, in hopes that economic growth--which, according to a surprisingly large number of economists, is the answer to everything from the debt problem to military entanglements, foreign relations, the refinement of quantum computers, time travel, and the heartbreak of psoriasis. The Chicago Bears will still be Da Bears however, Declan. I'm sorry.

    Okay, everyone with me so far? Good, good. Now listen up.

    The U.S. government budget is a big one. News flash: governments, or, more particularly, the politicians that run 'em, like to spend money. In recent years, drunken sailors on leave have started trying to model their own spending shenanigans on those of Congress, as this is where the really outlandish spending occurs, though Congress likes to try to push their responsibility off to others. This year's budget calls for the U.S. to spend about $6.27 trillion, give or take. The federal government won't take in that much, however--only about $5 trillion, and that's only if Vinnie puts the squeeze on a few more people than he usually does for us. So, we've got (again) an annual deficit that'll accrue of about $1.3 trillion for this year. That will get added to the debt, and next year, we're almost certainly gonna do it again.

    But wait, some folks say, we gotta quit spending so much. Everyone knows you can't just keep spending more than you make.

    Well, actually, some economists see no problem with continually spending more than one makes, as long as one can keep borrowing money to pay for the things we're buying without having the cash to cover it. And the U.S. has, according to these economists and some of their hoity-toity-type friends with shiny leather shoes and suspiciously nice hair, perfected the sales routine by which the U.S. gets others to buy bonds "backed by the full faith and credit" of Uncle Sam, with continuing interest payments that just keep getting bigger. Which, in a sort of just-in-time production model of government financing, requires that the economy keep growing, at least enough that everyone holding U.S. bonds, T-bills, and the like, believes that they will keep getting their interest payments, and that there will remain an active and viable market for selling those bonds and bills. It's a free skate sort of affair that works okay as long as the music keeps going and everyone keeps skating.

    What happens when the music stops, or the U.S. government quits skating, and then quits paying interest, and the bond market just, well, kinda does a Jimmy Hoffa sort of disappearing act, and all those governments, big companies, rich people, pension plans, and so on discover that they're no longer receiving the interest payments due to 'em?

    "Oh, say it ain't so, Sammy boy!" they'll say. "Say it ain't true that you're not paying us. 'Cuz that would create a--what's it called, Tommy? Hardship? Yeah, a hardship. It'd create a hardship for us. 'Cuz we got bills to pay, too, and services to provide whut we gots to pay for--like our security plan wit' you, Sammy, that cozy little plan we've got in that North Atlantic Mutual Aid Society. Or our agreement with Uncle Xi over there to, well, kinda hold back on invading Taiwan, which we all know Uncle Xi has been wanting to do. And there's more.

    "But we gotta know we're gonna be getting our money, Sammy. Now, you might think you know what would happen if you try to stop payments, maybe hole up in your fortress and try to pretend the world ain't going to shit around you. But you don't know, Sammy, you don't know. Remember that ol' song, "Nobody knows the trouble I've seen? Well, Sammy, if you do the default thing, ain't nobody can imagine the trouble you're gonna see.

    "You probly got your people telling ya, 'No worries, Sam, we'll be okay. We just do this, do that, everyone knows we're good for it, it'll all come out in the wash.'

    "But the thing is Sammy, when it comes to this kind o' hardship, nobody knows nuttin'. We ain't been here before, and lots of people are getting nervous. And you know what happens when people get nervous. They start doing stupid shit, and their stupid shit generates more stupid shit, and some of it involves violent events and ever more violent events. Which are bad for business, Sammy, your business and ours, and makes it hard, maybe even impossible, for this to end without a really horrible mess being made Sammy. And I wouldn't want that horrible mess being made of my affairs, and ya know Uncle Xi ain't wanting no horrible mess being made of his affairs, and, well, one thing leads to another, and pretty soon everyone realizes that the horrible mess needs to be made in the affairs of them what started this. Which brings us back to you, Sammy. Capiche?

    "All I know is, Sammy, it would be so ugly as to make Willy the Rat look like a Playboy centerfold, only like a trillion times bigger, this ugly thing, than anything you can imagine. Let's not do this, Sammy. We got a good thing going here. Don't f--- it up."

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      Javier Seravalli

      I think the problem is that due to the fact that since the US is still the leader of an unipolar World, it is basically accountable to no one but itself. Nothing wrong with that except that regular Americans need to understand that very fact. There are institutions (The World Bank and the IMF) that push countries to re-structure their debts, even if the debt/GDP is below say 40%. What usually happens is the IMF force governments to adopt austerity measures, raise the interest rates on future (or current!) loans and cut aid. Lesser economies tend to have lower debt/GDP ratios as a result. With aging populations everywhere except Africa, sovereign debts are going to be the major global financial problem!

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      1. CatoTheElder

        A good point. Could be considered cheery—“accountable to no one” always sounds like the winner of the war—but, upon reflection, perhaps that makes it worse. There’ll be no one to turn to when the s*** hits the fan, the power then goes out (fans and lights and those new induction cooktops), and then municipal water supplies. Within what seems mere moments we’re back in the pre-industrial era, with the added disadvantage of having lost the skills to survive, let alone prosper, in those circumstances.

        I’m gonna need a drink.

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          Javier Seravalli

          One thing I forgot to mention is that the vox populi in those countries always blame the IMF, World Bank, their political class for the austerity. It won't be all that bad, the internet might aid in retraining folks on useful skills; no more pursuing bright shinning objects online.
          Cheers!

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  3. Wes.Bridges

    "For now, President Joe Biden has said he wants a “clean” debt ceiling increase and won’t negotiate with congressional Republicans over spending cuts."

    Nonsense.

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      Javier Seravalli

      Didn't Republicans and Democrats passed simple or "clean" debt increases for both Trump and Biden?

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    2. Hikingguy

      Nuts to Republican budget cuts. It was Republicans during Trump's term that delivered all those lovely tax cuts for corporations and the wealthy. Now the same Republicans scream about deficits. The base may be dumb enough to fall for that. Millions aren't.

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      1. Jfan

        While many of the Trump sycophants complaining about deficits now can't be taken seriously, I think many of them are morons rather than hypocrites. Furthermore, the tax law of 2017 may have made things worse -- or not; I read that corporate tax revenues rose after its passage -- but this was a small effect compared to the existing deficit spending.

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  4. Kgfroehle

    Thank you very much! As a non-economics major (nor even English, pace KDW), I've been wondering about this for some time. Your explanation has given me at least some idea. Even if it's akin to global warming scenarios.

    Now, what did I do with my Magic 8 Ball?

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    Ben Connelly

    Interesting to contrast this with the piece by Shay Khatiri and Michael Massa about liberalism. If anything could throw a wrench in the works, it’s a massive America debt crisis followed by a Chinese invasion of Taiwan. And yet, for all the talk of the inevitability of liberalism, too many Americans stubbornly persist in the idiotic belief that the government can just print free money for them and nothing bad will ever happen (or if the billionaires just paid their “fair share” math would become magic and it would all be paid for).

    Part of me thinks an actual default might be the only thing to wake us up and quit borrowing off of the backs of our grandchildren in the theory that it’s “compassionate” to pay for current generations’ health care by stealing bread from the mouths of unborn generations.

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    1. CB76

      "too many Americans stubbornly persist in the idiotic belief that the government can just print free money for them and nothing bad will ever happen"

      I disagree with your characterization of the social safety net as "just printing free money," but let me ask you this: insofar as the right has been screaming that "the sky is falling," fiscally, literally since the creation of Social Security almost a century ago, and given that the sky has stubbornly held fast for just as long, are the voters the idiots for dismissing as cranks the folks who keep insisting disaster is imminent, when that has proven time and time again to be false?

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        Ben Connelly

        The social safety net doesn’t have to be either fiscally irresponsible or debt-financed. But we don’t make the hard choices necessary (combination of tax increases and benefit reduction and spending cuts elsewhere etc.) to keep it fiscally responsible.

        The turkey is right that the farmer will feed him every day and won’t hurt him until the day before Thanksgiving when he’s no longer right. For years, a certain group of people worrying about pandemics was cast as being chicken little, but they were right eventually.

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        1. CB76

          "a certain group of people worrying about pandemics was cast as being chicken little, but they were right eventually"

          Well, depending on who you ask 😁. But I take your point.

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        Dusty

        I think “idiot” is much too strong a word as it’s a very complex topic, but I don’t think that just because the world hasn’t imploded yet means that we should just keep doing what we’re doing. You may disagree with the characterization, but you seem to imply that you agree with the intent that money is being printed for rather than proposing an argument that we’re not actually printing money. I mean hell, it’s not even the conservative Austrian school cranks, even Keynes said you’re supposed to pay down the debt and run a surplus in good times.

        I think the cranks have been way too apocalyptic about it to where everyone disregards them now. But for the past 8 years the debt has been higher than 100% of GDP. David Bahnsen had Lacy Hunt on his podcast just today talking about this and Hunt references a number of studies that shows that the result of excessive national debt is decreased GDP growth. Specifically, when your debt is higher than 100% of GDP for 5 consecutive years that it decreased GDP by 33% (I’m not sure if that’s an average or a minimum, either way our GDP decline has exceeded that, going from like 2.5% to 1.1%). It’s the law of diminishing returns.

        Bahnsen is really beginning to win me over with his thesis (and I guess the Lacy Hunt, Art Laffer, and - as I learned today - David Hume thesis) that the debt situation isn’t going to end in a hyper-inflationary explosion like many of the “cranks” have been predicting. Rather, as plenty of historical examples dating back to Rome show, it’s going be a slow, painful decline. Or, as Bahnsen and Hunt quoted Hume today, it won’t “end in a bang but with a whimper.” And that’s the Japanification thesis.

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        1. Wes.Bridges

          I mostly agree--except that I suspect there is some flashpoint (where, exactly, is the great mystery) at which the economy goes BANG! We watched the weirdness in the housing market over the past three years, and after the fact there have been some pretty interesting explanations, but let's face it; economics is alchemy. It might not go bang this time. You make money betting on the weather by assuming tomorrow will be just like today. But, intuitively, there's a tipping point. As B. Connelly suggests above, a Chinese invasion of Taiwan would likely do the trick.

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            Dusty

            I agree with that. That last point I think really underscores Ray Dalio’s thesis about big debt cycles and changing world orders. A Chinese invasion of Taiwan is exactly the type of event that ends that cycle and leads to a new world order.

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  6. Stephenholmgren

    Thank you - this is very helpful!

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    Cthocas

    Maybe this take will age poorly, but I think the "Joker wing" (great term) of House Republicans are financially self-interested enough not to crash the American economy. It's much harder to grift donations and kickbacks in a depression.

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    1. Jfan

      I am not sure all of them are smart enough to figure out the consequences of their actions.

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    2. Wes.Bridges

      Cynical, but probably not wrong. It would also crater their chances of reelection, and there's just nothing members of Congress love more than being reelected. Well, unless it's the personal fortune that customarily follows--or accompanies-- holding office.

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  8. DTruitt

    The chances of the Federal government defaulting on our debts is approximately the chances of Vladimir Putin becoming a champion of civil rights and peaceful coexistence. As in zero.

    Every time the debt limit comes up it results in mass amounts of breathless speculation that always comes to naught, because it a routine exercise in Congressional debate over fiscal policy between the two parties. The President has no authority to set fiscal policy, despite what a lot of people think. Per the Constitution.

    Republicans always use the opportunity of approaching the debt limit to extract fiscal concessions from Democrats, and Democrats always say they refuse to negotiate, and of course the two parties DO negotiate, and life goes on. With mass amounts of digital ink spilled in the meantime.

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    Lawrence D'anna

    It's so nice to see someone pointing out that appropriations are laws too, and that when we hit the debt limit the president's choice won't be whether to break the law, but which law to break.

    Most journalists seem to report this story like the inevitable alternative to a negotiated agreement is default. I think when push comes to shove the president will do what presidents usually do these days, which is to act unilaterally. Usually that's bad, but in this case I think it would be the only responsible choice Biden could make.

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    1. DTruitt

      Presidents have no such power to "act unilaterally". Per the Constitution, only Congress has the power to set fiscal policy, including taxation, appropriations, and borrowing. To the extent that Congress delegates to the Fed on debt management, that is still in accordance with Federal law, and not a lawless exercise as you suggest.

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        Jason

        As Price began his piece with, that's the conundrum here. The president will have to act unilaterally if Congress chooses not to act at all - i.e. the president will have to choose what law to break.

        Congress has already set fiscal policy, has already apportioned money (that isn't available without more borrowing). So, break that law (by not borrowing)?

        Congress is (maybe) demanding no more borrowing (for money that Congress has already apportioned). So, break that law instead (by borrowing)?

        And, arguably - as Price noted - the 14th Amendment may be involved.

        There is lawlessness and irresponsibility, and it is everywhere. In this case, it is Congress who has chosen to create and may choose to force that lawless situation. I don't think it will come to that, but mostly because it hasn't before and all of the smart people don't think it will this time. A tenuous hope, at best.

        Here, possibly, the worst case scenario from a constitutional standpoint is also the worst case scenario from an economic standpoint. If the U.S. defaults, then we should expect all manner of nonsense from the voters and their representatives in response to the economic fallout (see e.g. Great Depression). If you don't think the jokers in Congress won't radically shift positions in response to their voter's complaints, then you haven't been paying attention.

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        Lawrence D'anna

        Whether they have the legal authority and whether they have the practical power to act unilaterally are different questions.

        Recent experience shows that they do have the practical power at least in the short term. Congress's only fast recourse would be veto-overriding legislation or impeachment. Both of these require a supermajority at least in the senate, which isn't going to happen. The unilateral action can be challenged in court but that will probably take months or years to resolve.

        As to constitutional authority, the outcome that most people seem to think is the default is ... default. That is, failure to pay the government's debt when it comes due. This is expressly prohibited by the 14th amendment, so the president obviously does have the authority to not do that. If default is ruled out, the only other options are ignoring the debt limit, or ignoring appropriations. But both of these options are illegal. Ignoring the debt limit is not more illegal than ignoring appropriations. They're both illegal. So the president is in an impossible situation. Congress has the authority to set fiscal policy, but they have set a fiscal policy that is literally impossible to execute.

        If the law doesn't instruct the president on what to do in that situation, then it seems clear to me that the executive power vested in the president includes the power to decide.

        So in this case, I don't think unilateral action would be lawless at all. What's lawless is congress creating a situation where every course of action the treasury can take is illegal.

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        1. DTruitt

          No the power to decide does not rest with the President - if resides always with Congress. This has already been decided by SCOTUS in multiple cases striking down presidential attempts to sidetrack Congress, including striking down attempts to use impound powers (refusing to spend what Congress appropriated) and the line item veto and most recently attempts by Biden to legislate without Congressional authority (via the “major matters” doctrine).

          We do not have a king or a dictator. We have an administrator. Congress sets Federal policy, taxation, spending, and borrowing.

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            Lawrence D'anna

            Ok so if the president lacks the authority to refuse to spend what congress appropriated, and he lacks the authority to borrow more money, and he lacks the authority to default on the debt.... what's he supposed to do? What legal course of action is there?

            [edit] One alternative is to mint the trillion dollar coin and deposit it at the fed. If the fed failed to react to this, it would cause a huge spike of inflation. So what the fed would probably do in this case would be to sell a trillion dollars worth of treasury securities. The fed currently owns about 5 trillion of these, so until Biden tries to mint the sixth trillion dollar coin, this whole operation has no net effect on the combined fed/treasury balance sheet. It's economically the same as just ignoring the debt limit. Once he mints the sixth coin though I'm not sure what happens. Is the fed allowed to issue its own bonds?

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        2. Steve Smith

          And Imperial Presidential power again increases due to the fecklessness of the proper legislative bodies.
          But I think you make a reasonable point.

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          1. DTruitt

            There is no such thing as “imperial presidential power”. The US does not have an emperor.

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  10. Pishposh

    Not raising the debt ceiling is, without a doubt, the single dumbest thing this Congress could do. That they are even threatening to do so is the second stupidest thing on the list. As such they have already proven themselves to be utter morons. And this congress is only weeks old… What have we the voters wrote?

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