Default Won’t Happen

Default won’t happen.

This chart shows why the U.S. Government will not default on its debt, should it hit the statutory debt limit set by Congress (a limit that the Treasury Deparment suggests may be reached later this month).

(Click on image to see larger version.)

(Image by Matt Battaglia, FreedomWorks Creative Manager, October 7, 2013.)

Look at the red spending bar. Zero in on the small section at the far left, marked ‘Interest on Debt.’ Now compare it to the entire green tax revenue bar above it, marked ‘Income.’ The two bars aren’t even close in length.

Uncle Sam takes in vastly more money each day than he needs to pay principal and interest on U.S. government bonds. That’s what a ‘default’ is—failing to pay your creditors on time.

Were we to arrive at ‘X day,’ meaning the day when the statutory debt limit is reached and the president can no longer legally borrow on the credit of the United States, the president would not default. Rather, he would be forced to decide whom to pay first, and whom to pay later when sufficient funds become available. This is called prioritization.

No statute bars the president from prioritizing holders of U.S. government bonds over others to whom the government also has financial obligations. Some lawyers contend that the U.S. Constitution actually requires him to do so (14th Amendment, section 4). Regardless of the law, every president, including the current one, when the question comes up, swears publicly never to do anything that would diminish the ‘full faith and credit’ of the United States.

This term, ‘full faith and credit,’ is important, and, at the risk of boring the reader, I want to explain why. ‘Full faith and credit’ is a term of art, with a specific meaning. ‘Faith’ is a word from the world of contracts. It means ‘keeping your promises.’  ‘Credit’ is a word from the world of finance. It means ‘having a reputation for always repaying your debts to creditors, on time, in full, without fail.’ Creditors are people who have lent you money. Even the seemingly minor words ‘full’ and ‘and’ in the phrase are important: they narrow its meaning.

The precise meaning of the phrase is: ‘always paying back those who have lent you money, on time, in full, according to the terms of the contract, without fail.’ It does not mean: ‘always paying your bills on time — any kind of bill.’ So the key element in the definition is ‘those who have lent you money.’

Another clue that the term has the more narrow meaning I’ve given is that we don’t often hear it used outside the context of government debt. We don’t hear people talk about the full faith and credit of BankAmerica, or of Joe Citizen. We do hear about the full faith and credit of the United States. That may be because governments are held to a higher standard than other kinds of debtors, and rightly so. They have the power to tax—to take their citizens’ or subjects’ money by force. Governments don’t have a good excuse for missing payments to their creditors.

When someone purchases a U.S. government bond, he is lending money to the U.S. government. The ‘full faith and credit of the United States’ means Uncle Sam’s reputation for always paying promised principal and interest to holders of bonds that it has sold to them. It doesn’t refer to Uncle Sam’s reputation for paying others to whom he may owe money. While other kinds of government payments—paychecks, benefit checks, reimbursements, financial grants of various kinds—may be subject to the terms of a contract and thus matters of ‘faith,’ they are never matters of ‘credit.’

Okay, now that we’ve beat that dead horse into the ground, let’s finish off the ‘default’ canard by challenging ourselves with an example. Let’s take the politically hardest example we can think of: Social Security.

What if Social Security checks don’t go out on time, as scheduled? Is that a default? No. Social Security is paid out monthly, usually transferred electronically to retirees’ bank accounts. Social Security payments are usually made on: 1) the third calendar day of the calendar month, and on the 2) second, 3) third, and 4) fourth Wednesday of the month. Let’s say we hit the debt ceiling on the second Monday of the month, and, come the immediate following Wednesday, the president runs short of cash and finds he can’t make the regular Social Security payout. What does he do? He has no choice. He can’t pay it. So he has to postpone it for, let’s say, one week, due to lack of sufficient funds.

(This is very unlikely to happen, by the way. Look at the chart again.)

In this, the ‘worst of all possible scenarios,’ retirees will be inconvenienced, to be sure—some, severely. Doubtless many will cry, ‘Breach of faith!’ But none could truthfully cry, ‘Default!’

Remember, ‘default’ is when you fail to pay your creditors. Uncle Sam will keep doing so, no matter what. Withe the U.S. dollar serving as the world’s reserve currency, and based on nothing more than the full faith and credit of the U.S. government, a bond default by that government can have catastrophic economic consequences. But markets don’t much care about that government’s ‘debts’ to retirees. They do care a lot about its debts to creditors. Those who warn of a ‘default’ ‘rattling’ markets and possibly causing ‘economic Armageddon’ are either confused or consciously trying to confuse.

Yeah, you may say. But what about market volatility? Just talking about ‘going past X day’ will rattle markets, and perhaps even trigger a recession! Maybe, maybe not. Uncle Sam has a perfect record when it comes to debt service. He has never yet missed an interest payment on U.S. government bonds. (Okay, he did once, unavoidably, in 1979, due to a computer error, but the amount was so small and the delay so brief that it had no discernible effect.)

But Uncle Sam has missed other kinds of payments. Many times. And the world did not end. Has the IRS ever been late in sending you your tax refund? Has Medicare ever been late in reimbursing a doctor or hospital? Of course! No serious observer regards those kinds of delays as ‘defaults.’

Delaying tens of billions in Social Security benefits would not rattle financial markets one-tenth as much as would a failure to make a tiny, legally obligatory interest payment on a series of U.S. Government bonds.

Why is every president so determined to avert a true default? Because no president wants to be the first to ruin our nation’s perfect repayment record. It would reflect very negatively on his performance as president. It would be a black mark on his legacy.

In the event the president does run out of borrowing headroom, he will prioritize.

Default won’t happen.