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  • Oct 2, 2014
  • Updated: 10:41am
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UNITED STATES

Q&A: how and when default on US debt could happen

The US is careening towards what could be a calamitous default on its debt because of political dysfunction in Washington. The Treasury says it will hit the nation's US$16.7 trillion debt cap by October 17. Here are some questions and answers about how and when default could happen

PUBLISHED : Wednesday, 09 October, 2013, 3:36am
UPDATED : Wednesday, 09 October, 2013, 5:40am

How could the United States default?

Washington takes in about 70 cents in taxes for every dollar it spends, so it must borrow to pay its bills. This should be easy as there are plenty of investors who want to lend America money. The problem: Congress put a ceiling on government debt and lawmakers haven't struck a deal to raise it.

So will Washington go broke on October 17?

No, but it will be dangerously low on cash. The government has been scraping up against the debt ceiling since May and now looks set to hit it around mid-month. When it does, the Treasury thinks it will have about US$30 billion in the bank. As it won't be able to add to the national debt, bills will have to be paid with incoming revenues and cash on hand.

How long will the money last?

Not long at all. The Congressional Budget Office thinks the United States would start missing payments on at least some of its obligations between October 22 and the end of the month. No one knows the exact day because you can't know what tomorrow's tax revenues will look like. 

The United States defaults when the money runs out, right?

It depends how you define default. Historically, default is when a country misses a payment to a creditor. The Obama administration says default would include any missed payment, such as payments for public health insurance. The first really big bill due after hitting the debt ceiling is a US$12 billion Social Security payment on October 23. 

When would financial markets melt down?

Markets would be alarmed if it looked like bondholders would go unpaid for an extended period and might even panic if any government cheques were delayed. Many analysts think the administration would at least try to prioritise payments on the national debt, but Treasury officials say picking and choosing which bills to pay would be impossible. The first debt payments due after hitting the debt ceiling are on October 17, 24 and 31. The first of those shouldn't be a problem, according the CBO analysis. But there might not be enough money for the payments due on October 24 or 31.

How would default affect the economy?

It would sink like a stone. Once default began, the government would have to slash its spending overnight by about a third. The fiscal drag, if it lasted a full year, would be the equivalent of up to 4.2 per cent of national economic output, according to calculations by Goldman Sachs. That doesn't take into account the potential for a financial crisis. If investors lost their cool, stock markets could tumble, hitting pension funds and leading consumers to spend less of their money. Credit markets could freeze up because investors around the world might reassess the value of US debt, which serves as collateral for trillions of dollars in loans and other financial transactions. The Treasury has warned a default could trigger the worst recession since the Great Depression.

Is there an easy way out of this?

Washington's army of policy wonks have floated all sorts of ideas that could in theory resolve a debt ceiling crisis. Treasury could mint a US$1 trillion dollar coin and deposit it at the Federal Reserve, magically topping up government coffers. The Obama administration could unilaterally raise the debt ceiling by invoking the 14th Amendment of the US Constitution, which some scholars read as prohibiting a default. The White House has ruled out both approaches. That they are even being considered speaks to the manufactured nature of Washington's crisis. The United States isn't at risk of default because its economy is failing. Its political system is just increasingly dysfunctional, and the most plausible resolution to crisis would be a deal between the White House and Congress.

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