Could We Ever Default on the National Debt?
Congressional leaders spent the weekend arguing over the need to raise the federal debt ceiling. Treasury Secretary Timothy Geithner has warned of the catastrophic consequences of a default, which he says could occur as early as July if lawmakers won't grant permission to borrow more money. Wait, if the government were really at risk of default, couldn't it just print enough money to pay its loans?
No. The independent Federal Reserve manages the national money supply to maintain stable credit conditions and prevent systemic economic risks, not to prop up the Treasury. Neither the president nor the treasury secretary can order it to print money. In addition, the Fed isn't a charity—it's a bank. It doesn't give money away without taking something in return. When the central bankers issue money to commercial banks, they take mortgage-backed securities. When they ship cash to Uncle Sam, they get Treasury bonds. If the government hits the debt ceiling, the Treasury won't be able to issue any more bonds.
Geithner has laid out a handful of extremely limited, technical actions the Treasury might take to prevent the country from reaching the debt ceiling, but those would buy just a few extra weeks of solvency. If Congress were to hold the line on the debt ceiling over the summer, the government would have to take truly unprecedented steps to avoid default.
One possibility would be to sell off federal lands. The government could offer, say, Yellowstone National Park, Andrews Air Force Base, or the Washington Monument at a public auction. Or, it could give the properties to the Fed in lieu of Treasury bonds for a cash infusion. (The Fed, of course, would have to agree to such a trade.) While such a move is politically unpalatable—and highly improbable—federal lands represent an enormously valuable asset. No one has ever been able to put a reliable estimate on the value of our more than 600 million acres of land, but if we were to assume—admittedly, without much evidence—that it's worth about the same as private property on an average, per-acre basis, Uncle Sam is sitting on more than $10 trillion in real estate. That would be enough to pay the interest on the nation's publicly held debt—the portion that's owned by investors like China or Warren Buffett, as opposed to government agencies—for the next 50 years. Or the government could retire the publicly held debt [PDF] outright.
So what would happen if the government did default on its debt? Well, there are two kinds of default. In the first scenario, the government simply wouldn't be able to cover its interest payments—in other words, what ordinary people mean when they use the word default. The results of this would be catastrophic. When creditors suspected that things might play out this way in Argentina in 2001, that nation's interest rates rose 5 percent [PDF] in a matter of months. A similar spike in Uncle Sam's average interest rate would increase the federal deficit by 30 percent in the first year, with a snowball effect going forward. The good news is that we're a long way from reaching that kind of crisis. Last year, the government paid $213 billion in interest on its publicly held debt. That accounts for just one-tenth of government revenue.
The second default scenario is more likely. In that case, the government would have enough money to pay interest to its creditors, but not enough to issue Social Security checks or pay soldiers' salaries. There's no analogue to this kind of default—if default is the right word—in the private sphere. Economists disagree on its significance. Secretary Geithner insists that it's "default by another name," since it would indicate the country's willingness to walk away from financial commitments. Others have argued that prioritizing debt-service payments, and walking away from entitlements or discretionary spending, would actually make us seem more reliable (and deserving of low interest rates), since it would establish just how seriously the U.S. takes its debt payments. At this point, it's not clear how, exactly, this would play out.
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Explainer thanks J.D. Foster of the Heritage Foundation, Douglas Holtz-Eakin of the American Action Forum, and Jeff Krauss of the Bureau of Land Management.