Because the U.S. hit its debt ceiling on Thursday, and because Congress has begun to consider a firm debt ceiling, readers worry that at some point Washington might find itself unable to pay interest on its bonds, or even redeem them when they come due. The concern is understandable. Theoretically, a rigid debt ceiling could hobble Washington’s ability to pay what it owes. But practically speaking, this is not going to happen. As a worry, default should be far down on any list of concerns; actually, it should be put out of mind. To be sure, Wall Street has expressed concerns, but these pros are less worried about default than about how Washington and others will respond. They worry especially about tax hikes, but that is a subject for another day. On the issue of default, a few observations should make this clear:
- The United States has never defaulted or failed in any way to pay its debts, or the interest on them, in the 234 years since it began operations under constitutional government in 1789, when Alexander Hamilton established the promise to pay the government’s debts as the rock on which the country’s financial system, and by extension its economy, rests.
- It’s not even clear that a debt ceiling could stop the redemption of bonds when they matured, because a maturing bond would reduce the outstanding debt and thus allow Washington to issue a new bond to make the payment – which is how the Federal government has always operated when existing debt comes due.
- In a pinch, the government could meet its interest obligations by taking funds from other agencies – not mandatory programs like Social Security and Medicare, but from what the budget calls “discretionary spending,” such as grants and even defense spending. Such an act would, of course, gore many a political ox, but even Congress would accept such pain in their recognition of all that depends on meeting the Treasury’s debt obligations.
- The Federal Reserve (Fed) owns a huge portfolio of Treasury debt which, in an emergency, it could forgive, thus bringing debt levels below whatever statutory limit Congress imposed and thereby freeing up funds that otherwise would have been used to pay interest on the debt held by the Fed.
- Alternatively, the Fed could issue new money for the Treasury to meet its debt obligations. Such an act would be inflationary, so the repayments and interest would have less buying power than the recipients would like, but the government nonetheless would meet its legal obligations.
The investment landscape today has its worries and its risks: the fighting in Ukraine; inflation, which, though moderated from earlier in 2022, is not going away any time soon; the prospect (some would say the likelihood) of recession; trade relations with China, and military risks in Asia. This is just a partial list. As I said on the outset, one would have to reach much further down the list before finding reasons to lose sleep over a Treasury default.
Bitesize Investing 