Top 3 Reasons the US Won’t Default on Its Treasury Debt

This story from Wall Street Cheat Sheet

There’s been a lot of talk about the US defaulting on its Treasury debt. As I wrote at economist.com:

A default would result from failure to pay principal or interest. The debt ceiling doesn’t bar either. Treasury can roll over maturing issues so long as the overall stock of outstanding debt doesn’t rise. (A caveat: Treasury must invest surplus Social Security and Medicare taxes by issuing non-marketable debt to the plans’ trust funds, which erodes the remaining capacity for marketable debt.)

But, revenue is more than enough to cover interest charges.

Lou Crandall of Wrightson ICAP has a chart that shows in every month this year, projected cash receipts comfortably exceed interest payments; the narrowest margin comes in November, when receipts exceed interest by $131 billion:

So, here’s 3 reasons the US won’t default on its Treasury debt:

1) Treasury Can Easily Remain Current on Existing Debt …

… provided it is willing to suspend some non-interest outlays.

2) The United States has NEVER Defaulted

The fourteenth amendment to the US Constitution says: “The validity of the public debt of the United States… shall not be questioned.” The Supreme Court has added it also bars Congress from voiding a government bond (although not from abrogating the gold clause as it did in 1934). I dug deeper into the legal maze:

Although, Treasury would pay obligations in the order that they come due, which could clearly mean missing an interest payment, some statutes, and the actions of the Clinton Administration in 1995-96, suggest that non-interest obligations are not sacrosanct. Several laws explicitly consider the possibility of late payment; the Prompt Payment Act dictates the interest penalties the federal government must pay for late payment to commercial vendors while the Internal Revenue Code does the same for late tax refunds. During the government shutdown of 1995-1996 (which was triggered not by the debt ceiling but by failure to enact appropriations), the Office of Management and Budget apparently did establish priority among various outlay categories. However, that would not have addressed bond interest which is subject to a permanent appropriation.

In early 1996, Bill Clinton warned that because the debt ceiling had not been raised, Social Security cheques might be late. This scared Congress into passing a small increase in the debt ceiling solely to meet Social Security payments. Treasury could acquire considerable additional borrowing room by not issuing non-marketable debt to the Social Security and Medicare Trust funds and by failing to rollover existing issues as they come due, and issuing IOUs in their place, as it does with the civil-service pension funds. While it seems to have rejected that option in the past, I’m not sure it is legally off limits. (Though this simply means replacing one IOU with another, it would be politically explosive; the public thinks of the trust funds as inviolable lock boxes, not accounting entries.)

Thus, it seems to me that if Tim Geithner has to make a choice, he can, and should, prioritise bond interest.

3) The US Cannot Afford to Default

The federal government now has to borrow about 40 cents of every dollar it spends. A prolonged inability to meet 40% of its obligations would sow economic disarray, trigger litigation, and eventually raise doubts about its ability to meet any obligations. Failure to raise the debt ceiling need not entail default; but it would still ding Uncle Sam’s credit rating.

Greg Ip is the US Economics Editor at The Economist and author of The Little Book of Economics: How the Economy Works in the Real World.

Don’t Miss: A New Deal for the 21st Century: Less Entitlement, More Accountability >>

Improve Your 2011 Financial Health: Join the winning team of stock pickers with Wall St. Cheat Sheet’s acclaimed premium newsletter >>

Read more at Wall Street Cheat Sheet – The Scoop