Even If There’s No Default, There Will Still Be Pain

The idea that we can avoid the consequences of failing to raise the debt ceiling is patently absurd.

 

Let’s take a face value for a moment the arguments made by some on the right that there is no real danger of the United States slipping into default if we fail to raise the debt ceiling by August 2nd. Let’s also ignore the warnings from both major credit reporting agencies that a failure to raise the debt ceiling could lead to a downgrading of the U.S.’s credit rating even without an immediate default. Let’s also ignore the President’s warning that failure to raise the debt ceiling could potentially prevent the government from making Social Security payments. Even if we do all of that, however, the one thing that can’t be ignored will be the economic shock that will result from the immediate need to cut federal spending by 44%:

The US government is the largest purchaser of goods and services on planet earth.

The government buys everything from equipment for cancer research to metal for warships to toothpicks for federal cafeterias. Suppose the governmetn had to cut 44% from its budget on 2 weeks notice? How sharp a shock would that be to the world economy?

Here’s a comparative. In the worst quarter of 2009, American consumers cut their spending by … not 44%, not even 4.4%, but 1.2%. That 1.2% drop in consumer spending helped tumble the US economy into the worst collapse since the 1930s.

The US consumer sector is even larger than the federal government sector. But it’s not unimaginably larger. US consumers spend about about $10 trillion a year. The federal government spends about $3.4 trillion.

If a cut of 1.2% from $10 trillion was an economic shock, a cut of 44% from $3.4 trillion will be a much, much, much bigger shock.

We’re not just talking about transfer payments here. On a daily basis, the U.S. Government conducts business with a wide range of private business. Some of them simply sell to the Federal Government the same things they sell to the private sector, whether its copier toner or a new car. Others, however, are more specialized and work solely for the Federal Government, sometimes only on one contract at a time:

Imagine that you are an information systems vendor with a contract to service the computers of the Social Security Administration. You have a contract worth $12 million a year. It’s your single biggest contract.

Sometime around August 1, you receive word that the federal government will not be able to pay your contract. The government does not know when it will regain the ability to pay.

What do you do?

For starters, you sue. You may not be a bondholder backed by the full faith and credit of the United States. But you do have a legally binding contract, enforceable in a court of law. The money is owed and must be paid.

The second thing you do is you go to the bank to borrow some money to cover your payroll pending payment of the contract. Maybe the banker lends you the money. Maybe not.

If not, the third thing you do is lay off people. You’re not being paid, so of course you cannot afford to pay out.

The fourth thing you do is try to cut other short-term costs. You test how long you can defer payments to your suppliers.

The fifth thing you do is begin to default on your own financial obligations: the mortgage on the office building, the line of credit that temporarily sustained your employment.

Now those suppliers face the same cycle of options as you previously faced: (1) litigate, (2) attempt to borrow, (3) lay off, (4) defer payments, (5) default on their own obligations.

Imagine that scenario being repeated hundreds of times across the country, and then think about how it will radiate out into the wider economy. Government contractors deprived of payments due to them will end up spending less in  the wider economy, and so will their employees. The chances that this shock would be enough to send the country into another recession would seem to be pretty high given the magnitude of the cuts that would have to take place over a short period of time. There is, it seems to me, a difference between favoring massive cuts in government spending (which I do) and advocating a policy which would suck more than a trillion dollars of liquidity out of the economy over the course of a short period of time. That’s what makes the argument that we don’t have to raise the debt ceiling so stupid and irresponsible, it has no connection to the realities of the economy we live in where large segments of the economy conduct business with the Federal Government on a daily basis. Cutting them off at the knees makes no economic sense, and is inevitable going to cause problems.

Moreover, as David Frum notes, economic conditions right now are so weak that it wouldn’t take much for things to get worse:

1) The consumer is tapped out, still deeply in debt from the housing bubble, and facing the continuing depreciation of the most important consumer asset, housing.

2) Everybody expects a deal to happen at the last minute, so a non-deal would jolt and shock markets.

3) A congressional forced non-payment of US bills would represent a signal and shaming failure of US institutions, sowing doubts about US credibility and reliability among investors and vendors worldwide.

All in all: it would be pretty bad.

Would it be as bad as an actual default on the debt itself? Probably not, because that would lead to a collapse of the dollar and spiking interest rates that would increase the cost of borrowing for businesses and consumers alike. Nonetheless, those on the right who say that we don’t need to raise the debt ceiling have an obligation to be honest about the path that they are proposing. It would be painful, it would most likely cause growth to slow and unemployment to rise, and it would sink the government further into paralysis.

 

FILED UNDER: Congress, Deficit and Debt, US Politics
Doug Mataconis
About Doug Mataconis
Doug holds a B.A. in Political Science from Rutgers University and J.D. from George Mason University School of Law. He joined the staff of OTB in May 2010 and contributed a staggering 16,483 posts before his retirement in January 2020.

Comments

  1. Vast Variety says:

    Nonetheless, those on the right who say that we don’t need to raise the debt ceiling have an obligation to be honest about the path that they are proposing. It would be painful, it would most likely cause growth to slow and unemployment to rise, and it would sink the government further into paralysis.

    Maybe that’s what they want. They could be betting that the public would punish Dems and Obama and reward Republicans for such a disaster. If they are I think they are going to be disappointed.

  2. As I noted in an earlier there is going to be pain no matter what. We now must decide whether we keep digging or start trying to get out of the hole we are in.

  3. MBunge says:

    “As I noted in an earlier there is going to be pain no matter what.”

    Hmm. Cripple the economy vs. raise taxes on people who make over $250,000 a year. Yeah, that’ll cause the same amount of pain.

    Mike

  4. hey norm says:

    We’re on a fools mission as it is. There isn’t a debt crisis – the debt is bigger than I would like, and I said so when Bush was spending all that money, but it’s not a crisis – as witnessed by the bond markets. There is a demand crisis, and hence an employment crisis – as witnessed by 9% unemployed. Nothing in the proposed deals is going to help that. Defaulting, as pointed out above, certainly will not help that.
    But it also strikes me as funny that everyone’s 401K’s are finally back on track, after the Bush crash of ’07 and ’08, and the so-called republicans want to just wipe away that value again by flipping out the market with this pointless default. What’s up with that?

  5. Yes, because the great evil is that anyone makes over $250,00 a year. Got it.

    Enjoy your echo chamber.

  6. ponce says:

    Enjoy your echo chamber.

    I’m confused, Charles,

    Are you guys against the debt or against higher taxes on the rich?

    If both, what are you against more?

  7. DMan says:

    @charles austin:

    “there is going to be pain no matter what.”

    That’s a pathetic response to this post, especially coming from someone who supports the notion that any increase of a small amount on the revenue side of the equation to deal with the debt cannot be tolerated.

  8. David M says:

    @DMan: Astute comment of the thread, that is.

  9. Davebo says:

    The assumption that Charles or the GOP in general are serious about the debt/deficit is the first mistake made in these conversations.

    Neither care a whit about either (as shown by their complacency or complicity in creating it over the past decade) and both now use it in a childish power play.

    Basically it’s “I pooped my pants! Why haven’t you changed them yet??”

    As to those who enable the excrement, I’ll defer for know. But it ain’t Chuck here.

  10. mattb says:

    @Dman —

    His position is “Pain is always ok, as long as someone else is suffering it.”

    Though I also suspect he would respond “The oppressive taxes I’m already paying are pain enough. Especially since I don’t benefit from them.”

    Of course, in such a comment one must also pick up the old story of the free rider. And strangely, that rider seems what certain people resent and at the same time desperately want to become.

  11. Liberty60 says:

    Begging the indulgence of the blog host, I will repost from an earlier thread-

    we spent in FY 2010 roughly-
    1 Trillion for Defense/ Homeland Security;
    1 Trillion for Social Security;
    0.6 Trillion for Medicare;
    0.4 Trillion for debt service
    0.5 Trillion for every other damn thing the Govt does.

    3.5 Trillion total spending offset by:

    1 and change Trillion in Social Security payroll tax;
    1 and change Trillion in other taxes.

    2.1 Trillion in total revenue.

    So there we have it- which of these numbers would Republicans want to change?

    Seriously- I keep asking this same question, and all conservatives do is adamantly insist that there are trillions of fraudwasteandabuse in there, just waiting for a steely eyed Republican to cut.

  12. Wayne says:

    Even if debt ceiling is raise there will be pain either with too much spending, bankrupting this country with too much debt, or hyperinflation.

    Having the inefficient Government spend other people money is piss poor plan to expand the economy. Stacking on outrageous debt to do so is even worst plan.

  13. hey norm says:

    Hehehe…McConnell – ‘ol turtle face – just said he’s willing to give Obama the ability to raise the debt ceiling on his own if the Republicans are allowed to make political hay out of it until the 2012 election. I’ll leave it for the OTB staff to post details – but once again the so-called republicans have proven they are not serious about the debt.
    Sad what has become of a once great political party.

  14. Liberty60 says:

    @Wayne:

    Having the inefficient Government spend other people money is piss poor plan to expand the economy. Stacking on outrageous debt to do so is even worst plan.

    But isn’t this exactly what the government did during WWII?

    Back then, debt was much higher, and marginal tax rates much higher still.

    How’d that work out?

  15. Liberty60, really? You want to pull out WWII? Are you saying that defeating the Axis powers is the equivalent of funding the day to day functioning of the government in 2011, or are you planning on the same sort of rationing and American dead that we had from 1941-1945?

  16. Liberty60 says:

    I am saying that economically, we face the same level of debt- and back then we found a solution.

    A solution that involved high taxes on the wealthy, and heavy government regulation of, and investment in, the private sector.

    How’d that work out?

  17. Don’t forget destroying the rest of the industrialized world’s manufacturing capacity. That had kind of a signifcant role in what followed in the ’50s and ’60s.

  18. Rob in CT says:

    Yes, that’s true and shouldn’t just be forgotten. The USA isn’t going to get the sort of favorable lay-of-the-land we had in the 1950s and 60s again anytime soon, unless half the world blows themselves up.

    So, while I do think it’s valid to point out that fiscal stimulus worked to pull the USA out of the depths of the depression and also that WWII was a massive government jobs program… this is 2011, not 1930 or 1940.

    The GOP position is fundamentally crazy, IMO. There are two reasons this pisses me off: 1) the obvious non-zero chance that they will do real damage to the country; and 2) a non-crazy GOP might actually do some friggin’ good.

  19. Xanthro says:

    If a cut of 1.2% from $10 trillion was an economic shock, a cut of 44% from $3.4 trillion will be a much, much, much bigger shock.
    ————————————————-

    Is someone math challenged? Those numbers are almost the same.

    1.2% of 10 = 1.2
    44% of 3.4= 1.5

    1.5 trillion is not much much more than 1.2 trillion.

    Though I think the author meant something different. A 1.2% quarterly drop isn’t compared to the yearly 10 trillion. Though it’s hard to know what the person meant when the math and logic is this far off.

  20. Ebenezer Arvigenius says:

    Is someone math challenged?

    Yeah. Probably the one who does 10/100*1,2 and gets 1,2 instead of 0,12. Or, in other words, the systematic shock would be roughly be 12 times the size.