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.