A Debt Default Is Serious, But Not the End of the World
The question of the consequences of a default on the debt is one of the rare occasions where it is possible to say that both parties deserve serious blame. Republican Tea Party types are speaking nonsense when they imply that it would be painless. On the other hand, Democrats have been equally silly in treating it as an end of the world scenario.
First of all, it is important to note that we really don't know what President Obama will do if the debt ceiling is hit. He will then be subject to contradictory laws. On the one hand, the Constitution requires him to spend money appropriated by Congress. On the other hand, he is prohibited by the debt ceiling to borrow the money needed to carry through this spending.
Lawyers differ on what the Constitution would require the president to do under these circumstances. He may just carry through the spending mandated by Congress as if the debt ceiling does not exist. However for this discussion, I assume that he will treat the debt ceiling as binding.
Many of the tea party types have argued that Obama should prioritize interest payments on the debt, along with other categories of spending they favor, and thereby avoid default. It is not clear Obama can do this prioritization even if he wanted to – the government's system of payments is not set up to stop tens of millions of payments on a dime – but even if he could there would still be serious consequences.
Tens of millions of people are expecting checks from the government: doctors owed money for treating Medicare patients, state and local governments expecting payments for a wide range of programs and tens of millions of people dependent on Social Security checks. If these people don't get their checks, the economy will take a big hit.
If the benign debt default story is silly, so is the apocalypse story. When the collapse of Lehman Brothers caused a tsunami in the financial sector, this was because trillions of dollars in assets, specifically mortgages and mortgage backed securities, were suddenly recognized as being worth much less than their face value. Banks and other financial institutions faced enormous losses, but no one knew who and how much.
Nothing like this will happen with government bonds. No one will doubt they will eventually receive payment in full, with interest. The delay in making payments will carry a cost, but no one is going to sell their bonds at a 20 percent discount because the government was a few days late with a payment.
And some of the alleged consequences would actually be positive. If the default led to the dollar losing its status as the preeminent reserve currency, this would mean a lower valued dollar. That is exactly what we have been pushing for with China and other countries. It would mean more net exports and jobs.
In short, default is serious. It is not the end of the world.
Dean Baker is a macroeconomist and co-director of the Center for Economic and Policy Research in Washington, DC. He previously worked as a senior economist at the Economic Policy Institute and an assistant professor at Bucknell University.