You’ve heard the warnings many times from every direction. In fact, it is almost all you hear right now: default is a serious threat if the debt-ceiling is not raised:
President Joe Biden and House Speaker Kevin McCarthy both said they had a productive debt ceiling discussion late Monday at the White House, but there was no agreement as negotiators strained to raise the nation’s borrowing limit in time to avert a potentially chaotic federal default. It’s a crucial moment for the Democratic president and the Republican speaker, just 10 days before a looming deadline to raise the debt limit.
The White House and GOP negotiators plan to meet again on Tuesday at 11 a.m. ET to continue negotiations on a months-long impasse over raising the nation’s $31.4 trillion debt ceiling before a default occurs….
McCarthy says he told Biden that there would be no agreement to a ‘clean’ debt limit deal which wouldn’t include spending cuts, and that he won’t agree to raise taxes … telling Republican lawmakers that ‘we are nowhere near a debt ceiling deal yet.’
I reported in The Daily Doom today about the White House warning a US debt default will cause stocks to plunge 45% and will crash the US into a deep recession. The news also told of how JPMorgan’s CEO, Jamie Dimon, is warning that commercial real-estate woes will be the next stage in an ongoing banking collapse. On top of that, he warned that just getting close to the “default” scenario could create a market panic:
US Default Scenarios Span From Localized Pain to Dimon’s ‘Panic’
JPMorgan Chase & Co. Chief Executive Officer Jamie Dimon warned earlier this month that even going to the brink is dangerous, with unpredictable consequences. “The closer you get to it, you will have panic.”
He’s not wrong about that, even though actual default is not going to happen. The fact is we are going to see another big stock plunge and the commercial real-estate crash he talks about as bringing down some more banks, regardless of whether the debt ceiling is lifted or not. It’s also a fact that the threat of default will expedite that crash even though a default will not happen and is not even a real risk of happening at the present time, strange as that will sound when everyone tells you the opposite, but I will explain in detail.
Everyone in stocks talks as if default is a thing that will happen if the debt ceiling is not raised. So, even though it is not, the fear is becoming palpable because it is what everyone believes. After all, our national treasurer, who certainly is no national treasure, warns routinely about default as if it is her only option when the bills come due if the debt ceiling is not raised. It is not, and she knows that. She’s lying.
All talk about a debt default happening if the debt ceiling is not raised is a lie by those who know better and a mistake in copying that lie by all the rest. You see, failure to raise the debt ceiling cannot force a single default on a single Treasury, even if the ceiling is not raised for years … unless the White House decides to create an all-out constitutional crisis by making payment of US debts it lowest payment priority. Neither will failure to raise the ceiling force Social Security payments to be reduced or stopped, even though Yellen, who loves to be Biden’s fear monger, has said otherwise in the past:
“Nearly 50 million seniors could stop receiving Social Security checks for a time,” Yellen wrote.
No.
However, there is the possibility that a government shutdown could delay how quickly that money reaches people.
Here is why we cannot and will not default if the law is obeyed
First, as for the bogus Social-Security part of the scare tactic, Social-Security income has exceeded its costs on average for a long time, and is currently running about par:
Since the mid-1980s, Social Security has collected more in taxes and other income each year than it pays out in benefits and has amassed combined trust funds of about $2.8 trillion, and the excess income is invested in interest-bearing Treasury securities.
Center on Budget and Policy Priorities
So, Social Security is still taking care of itself, and …
Social Security is “sui generis,” a legal term which means it is on its own
And it is still doing fine on its own. At least for the next few years:
Social Security, which was created in 1935, has never missed a benefit payment. One key reason why that will not change now is the fact that it is a pension plan, with a pension trust that is separate from the government’s general operating fund….
Even if the debt ceiling does not get raised, funds from payroll taxes would still continue to come into the government…. Those contributions go toward the program’s trust funds and are used to pay benefits.
Social Security is paying INTO its trust fund because it is making more than enough to pay benefits. Only that surplus can be borrowed by the Treasury in exchange for bonds. The Treasury cannot legally take ANY money from SS, and it can only borrow the surplus. Social Security has enough to run from its own contributions for another ten years before contributions drop far enough below pension withdrawals to be a problem. So, if the debt ceiling doesn’t get raised for a decade to where the Treasury cannot reimburse the surpluses it has borrowed when they are finally needed, then that will be a problem.
I give one caveat: There is never an assurance these days the government will abide by its own laws.
Second, statutory law and the 14th Amendment of the US Constitution both require the executive branch to pay all US debt in a timely manner:
(a) The faith of the United States Government is pledged to pay, in legal tender, principal and interest on the obligations of the Government issued under this chapter.
(b) The Secretary of the Treasury shall pay interest due or accrued on the public debt.
Contractual obligations may be treated as a debt, so not paying those obligations or paying interest on bonds or redeeming bonds when the mature is not a legal option. Therefore, the government will be forced to prioritized its payments of all expenses by putting all US debts at the top tier because those are further protected by the constitution itself. “Obligations” that are not contractual, such as money congress has designated for certain programs, is not a debt.
Among many other things, the part of the constitution you are hearing a lot about these days — the 14th Amendment — states,
The validity of the public debt of the United States, authorized by law, including debts incurred for payment of pensions and bounties for services in suppressing insurrection or rebellion, shall not be questioned. But neither the United States nor any State shall assume or pay any debt or obligation incurred in aid of insurrection or rebellion against the United States, or any claim for the loss or emancipation of any slave; but all such debts, obligations and claims shall be held illegal and void.
That applies to the president and the entire executive branch as much as to congress. All US debts must be paid without question. Although nothing is said specifically about timeliness, that is generally assumed.
What you hear no one in the mainstream media talking about, however, is the FACT that not all US government expenses are debts or even contractual obligations for ongoing work or past work.
The US debt now sits at almost $32 trillion. Biden does not question the US debt. He loves it — so much so that he plans to create a lot more of it by adding another $20 trillion over the next decade, and he wants to hold on to that plan. Now, you might think House Republicans are the champions here, battling against this huge expansion of debt. You would be sadly mistaken. House Republicans really love the debt, too, but just a little less: they want to nip that additional deficit spending down by a comfortable quarter to a mere additional $15 trillion in debt. That is what all the fighting is about.
To win this battle over a huge, fat set of annual Republican deficits versus a huge, fat, bloated set of annual Democrat deficits, major scare tactics are in order. So, both sides are wielding the default-scare budget ax to strengthen their threat against the other. Now, the fact that this is just a scare tactic that threatens something that won’t ever happen unless the president defies both statutory law and the constitution, does not mean major problems from the debt-ceiling fiasco are not possible. In fact, I’d say they are likely. Deployment of the debt-ceiling tactic could, all by itself, cause problems quickly at this point with the Yellen deadline for the US Treasury being only a week away.
However, you can be sure that Nana Yellen has hedged her deadline a little, and the way that she will do that demonstrates the very reason we will never have a debt default even without the debt ceiling being raised unless the president choses to create one.
The Treasury Department has asked federal agencies if they can delay payments, the Washington Post reports, citing two people familiar with the matter, as the Biden administration looks for ways to limp things along until a deal is struck – or June 15 quarterly tax payments roll in, buying Congress a bit more time to negotiate before the so-called “X-date” when reserves run dry.
Oh, so delaying payments is not necessarily debt default. What about stopping buying things so you don’t even have to make payments? More than likely, what Biden will do, instead, is choose to use the 14th Amendment at that point as an excuse for exceeding the debt limit by issuing more of the new debt that he likes; however, he will be abusing the constitution if he attempts that path because he has other options: (Of course, I give one caveat: there is never any assurance these days the government will abide by its own laws.)
What are the other options to default?
Math.
Math is the other option: US government revenue is estimated to come in at $4.8 trillion this year. That is revenue, not money raised from new debt issuance. Meanwhile, interest on the debt — the part the statute says must be maintained — is growing as a result of the Fed’s financial tightening and growth in government spending:
Net interest payments on the national debt rose from $352 billion in 2021 to $475 billion in 2022 — the highest nominal dollar amount in recorded history. Much of that increase was due to higher interest rates on U.S. Treasury securities. Although borrowing rose sharply over the past few years to address the COVID-19 pandemic, interest costs were muted as a result of low interest rates. However, as inflation rose to a 40-year high in 2022, the Federal Reserve increased the federal funds rate…. Those rate hikes, in addition to other factors, placed upward pressure on interest rates on U.S. Treasury securities…. Interest rates on U.S. Treasury securities are expected to continue to rise over fiscal year 2023. Because of that, CBO projects that interest payments on the national debt will increase an additional 35 percent this year, to $640 billion.
OK, the math from there is fairly straightforward: With a debt-service cost of $640 billion for this year, taken out of revenue of $4.8 trillion, assuming revenue doesn’t decline below estimates, that leaves roughly $4.2 TRILLION in cash flow from actual revenue for the government to operate on without raising additional debt. Since the debt ceiling does not forbid rolling over debt, but only adding new debt, the government’s only essential cost to avoid default is that interest of $640 billion. Any bonds that mature to where principle must be paid can simply be rolled over, though that will happen at a higher interest rate, making the interest’s consumption of that 4.8 trillion faster over time.
As the government has many expenses that are not contractual obligations, the government can choose to stop a huge amount of that spending that both Joe and the Repubs want to do, even though the Repubs want to do a little less of it to look like they’re accomplishing something. Mostly, they don’t want taxes going up on corporations to pay for Joe’s extra goodies. Don’t think that with a budget deficit craving of $15 trillion, this makes them some kind of marauding heroes. They are all mega spenders.
So, what is really at stake is not a default but a partial government shutdown. We’ve seen shutdowns before. Newt Gingrich played that brinksmanship game with Bill Clinton in a battle over the budget, not over the debt ceiling, in 1995, claiming the public would probably love him for letting the government shut down. Turned out the public did not, and Republicans got slaughtered over it. John Boehner played the brinksmanship game with Obama without a government shutdown, and the US debt ceiling got downgraded before the US went into default. (Note that I conflated those two incidents in the editorial for today’s Daily Doom.) So shutdowns are a way the government can reel its cash outflow back in line with its cash income, but they don’t go over well. They caused a major backlash against Republicans in 1995 and a huge plunge in stocks in 2011, and it yielded no results for Repubs in 2013, but the US never actually defaulted in any of those situations. The point is simply that shutdowns MUST be done by law before any default occurs because they CAN happen legally and HAVE while defaults CANNOT.
So, what actually will happen, instead of a default, is the government will become forced to shut down a lot of services. We saw how that worked in the past. National Parks got closed because the public would feel the crimp of that the most during the summer travel season and would rebel because everyone loves parks, which each side hoped would press the other to deal. All kinds of other programs can be cut back, some of which we saw in the past. NPR can get less funding to the extent that the government maintains any contractual obligations it has (as with everything else I’ll mention). NASA programs can be cut way back. Infrastructure projects slated for this year that are not yet under contract can ALL be eliminated. (Not saying that is a good idea, just that it is the kind of thing that constitutionally MUST happen before debt is defaulted on, and it CAN happen, though not without detriment.) Maintenance can be deferred on all government properties. School hours can be reduced. Heat or A/C can be reduced in government buildings. Government officials can fly less and do less governing — the part Newt mistakenly bet Americans would be thankful for. ALL foreign aid can be stopped. Non-obligatory welfare programs can be stopped or reduced — the part Dems are afraid Repubs will target in order to spare the corporate execs from getting their capital-gains taxes raised to match the rest of us. Congress could reduce all their own salaries and benefits. Military spending can be massively curtailed with all kinds of weapon development projects put on hold. Ukraine military aide can be ended.
That is a very short list of examples. There are ALL KINDS of things that can be cut before a single penny of debt interest gets defaulted on while all existing debt gets rolled over as it matures. So default is not truly is really on the line here. Curtailment of government IS. I’m not saying all of those are good ideas, but they CAN be done, while defaulting on the debt in order to avoid those cuts if the debt ceiling is not raised, would force a constitutional crisis.
Of course, I have one caveat: There is nothing to say in these days, when many branches of government appear to operate outside of the law, that Biden’s government will abide by the government’s laws. So, I’m not saying a default cannot happen; just that it cannot happen legally and won’t so long as all sides operate by the constitution.
Even liberal Larry Tribe, a Harvard Law professor, explained during the Obama era that …
if … [the government] does not have enough money to make all of the expenditures that Congress has required by law … it must prioritize expenditures: some payments simply have to be postponed until the Treasury has enough money to make them….
Section 4 itself distinguishes “obligations” from “debts.” On the one hand, it provides that the “validity of the public debt … shall not be questioned.” On the other hand, it declares “any debt or obligation incurred in aid of insurrection or rebellion against the United States … illegal and void….
Congress rejected an earlier version of the clause that would have protected “debts or obligations.” It seems that the framers of the Fourteenth Amendment deliberately decided to exclude ‘obligations’ from the Public Debt Clause. [In that “obligations” are only mentioned in the exclusion clause of the 14th Amendment.]
...The Public Debt Clause prohibits Congress from repudiating any debt already incurred. If Professor Buchanan were right that “debt” includes all spending commitments, then the Public Debt Clause would prohibit Congress from ever repealing or revising a legally authorized appropriation….
Therefore, it cannot be said that Section 4 itself forbids the prioritization of appropriations….
In a situation where the legislatively authorized spending commitments outstrip legislatively authorized revenue, it is impossible to honor both of these allocational arrangements at once. One of them must give way….
… it should come as no surprise that, as far as I am aware, no President of the United States has ever attempted to raise revenue without congressional authorization. By contrast, as Justice Scalia noted in his Clinton dissent, executive cancellation of congressional appropriations is far from unprecedented. For example, Ulysses Grant, Franklin D. Roosevelt, Harry Truman, and Richard Nixon all declined to spend money that Congress had appropriated….
… tradition confirms what history suggests: the principle against legislatively unauthorized raising of revenue takes precedence over the principle against executive postponements or even outright cancellations of legislatively authorized expenditure.
I do not mean to suggest that, if it becomes necessary for the President to prioritize expenditures, the President is free to use whatever priorities he likes. First, the Constitution itself requires giving some expenditures (such as the payment of judicial salaries … or payments on the public debt … priority over others.
In fact, government departments have many times failed to spend their entire congressionally appropriated budget. So, yes, it can be done and has been done many times.
That is how the Obama administration handled a similar situation, and note that the 14th Amendment does not require the national government to raise the debt ceiling either, but only to prioritize debt payments ahead of everything else, including tax wishes. The only time the government would be required to raise the debt ceiling to avoid a constitutional crisis would be if the interest payments were so high that even cutting all non-obligatory expenses would not leave the government with enough money to pay the interest on the debt. We are far from that.
So, threatening on either side to NOT pay the debt is childish because it is reckless with real risks of panic and credit downgrades. The real threat to be made is cutting government, and neither side really wants to do that, as we’ve seen through decades with each party under control leading only to more debt. The only exception to adding more debt in my 64 years came when Newt was speaker of the house and Hillary’s husband was president. They actually used this battle to create a surplus budget by cutting expenses and raising taxes to find the sweet spot. George Bush blew that all to hell with his Bushwhacked Tax Cuts, and we’ve never seen any hope of that happening since (just as I said back then we never would see happen again).
Moreover, Social Security cannot be cut or reduced without an act of congress because of its separateness by intent from the rest of government spending. While all of its excess funds must be loaned to the US government in trust, the US government is obligated to pay all of that back into Social Security AS NEEDED. Currently, SS still runs a surplus, so none of those bonds need to be repaid to the SS fund presently; there is enough revenue coming in from those making their FICA payments to cover all the current SS benefit payments. There could be problem, of course, with getting checks out on time if the government has to cut staffing; but technically I don’t think the law really allows even that. Though, I do have one caveat: it seems you can’t always trust the government these days to abide by its own laws.
Stocks will get chopped
The fact that failure to raise the debt ceiling has no potential to create a default on its own, however, does not mean credit agencies won’t downgrade US credit ratings ahead of a failure to reach a debt-ceiling agreement, as I’ve warned in past articles. That will cause its own credit problems, possibly wrecking havoc in bond land, and merely approaching that perceived deadline will create panic problems in the stock market, too, as Dimon warned. We have past knowledge of all of this to go by:
A new chapter of debate over the debt ceiling began in 2011, when sparring over spending between President Barack Obama and congressional Republicans resulted in a protracted deadlock. Congress eventually reached a deal to raise the ceiling just two days before the date that the Treasury estimated it would run out of money. However, the brinkmanship triggered the most volatile week for U.S. stocks since the 2008 financial crisis, and the credit rating agency S&P Global Ratings downgraded the United States’ creditworthiness for the first and only time ever….
When the debt ceiling was set to expire [again] in 2013, debate over the limit forced the government into a shutdown.
The stock market crash was so severe it was only saved by a pledge by the Fed to step in with a new QE program. The mere specter of default can push the economy into crisis, especially when the economy is in such a fragile state of being as it is now where banks are already getting destroyed.
Whether we reach agreement or not, stocks have big trouble ahead for different reasons caused by either scenario; yet stock-market bulls, who think with testosterone firing their brains, seem, as usual, blithely in denial of the trouble right in front of them.
If the debt ceiling is not raised and the government does reduce its operations and expenses, that has a major economic effect. It means millions of people don’t get paid and go on temporary unemployment, so the federal government gets stuck paying half their salary anyway. It means thousands of projects grind to a halt so there is a huge reduction in purchases of manufactured materials. Manufacturers lay people off. Transportation companies move less stuff, make less money and lay people off. Stocks go down more. On and on it goes. That means GDP certainly crashes into a deep recession, as the White House warned, although it clearly already headed that way last quarter.
If the debt ceiling is raised, stocks may do a whoohoo! rise for a few days, but then a different reality kicks in. Suddenly the Treasury is free to start issuing tons of bonds to make up for months of lost time. It will spread this out as much as it reasonably can to reduce the impact on interest. But the Treasury’s total lack of bond issuance for months has offset the Fed’s quantitative tightening in that the Fed has not been needed by the government during the time when the government has not been issuing bonds. Now, without the Fed buying new bond issuances anymore, bond interest will start rising again when the Treasury starts issuing more than ever to make up for its huge cash shortfall.
Far from being a risk-on stimulus, a debt-ceiling resolution will expose stocks to a correction as the resulting increase in Treasury issuance sucks liquidity from the system. No agreement would be negative for stocks, but even a detente is likely to lead to risk-off moves in markets.
It’s kind of a damned-if-they-do/damned-if-they-don’t scenario for stocks, and here is why:
When the Treasury issues new bonds, that drains banks’ of reserves as their clients, whether businesses or individuals, use the money they have deposited in those banks to buy the Treasuries. What happens is money moves from numerous banks’ reserve accounts at the Fed into the Treasury General Account at the Fed (the government’s banker) to purchase those government bonds, filling up the TGA, while drawing down bank reserves. The Treasury has no choice but to offer whatever combination of price and interest (yield) is necessary to attract all the buyers it needs. Without the Fed in the picture soaking up all Treasures now that it is doing QT, instead of QE, that may take some attractive interest rates.
Either way, the Treasury will sell all the bonds it needs to, and most of that money will come out of existing bank reserves or out of stocks to pass through bank reserves as people either use their deposits or sell their stocks to raise cash for Treasuries. (Investors may sell other assets, but those are not likely significant compared to using cash on deposit or selling stocks to raise cash. Some money may come out of the Fed’s Reverse Repo Facility from hedge funds. All that cash is just a pass-through in bank reserves, at best, so doesn’t help boost reserves as it is headed straight for the US Treasury to get those bonds while a lot of money is likely to come straight out of deposits at banks to head to the Treasury, and that does deplete reserves.)
That will be devastating for banks that are already seeing a huge devaluation in their existing bonds as the the low-interest bonds they hold in reserves, if sold, have to be priced further down than they already have to be in order to compensate for the freshly rising interest on Treasury issuances. The banks will have to price down to a falling market (bond prices fall when yields rise) at the same time they are having to pay out those deposit withdrawals from their reserves. So, it’s effectively a double hit to reserves. That means the banking problem we’ve already seen becomes exacerbated … considerably.
The stock market, which has punished banks a good deal this year, will resume punishing them even more by selling off more bank stocks, which may even be how people raise cash to buy the competing Treasuries, cyclically compounding the forces at play. The stock market will also have to compete against rising rates on default-free/risk-free US Treasuries, meaning money will be attracted away from most stocks in general. Of course, if banks start crashing again, as even Jamie Dimon says is likely (while secretly salivating over the prospect of feeding on a few of them), credit will tighten, consumers will tighten in concern, and stocks are likely to panic as Dimon has warned. And for that reason, maybe Dimon actually is panicked because the thought of a generalized stock crash, focusing on banks, may outweigh his vulture-capitalist interests of acquiring more banks at fire-sale prices because it can become very disorderly. I think he’d much prefer a few banks crash at a time and not a major pile-up.
While the Treasury will try to spread this out, it has no choice but to sell a lot of bonds quickly if the government intends not to shut down a lot of government activities quickly. So, the default scare is bringing trouble, no matter what, because our leaders are acting recklessly when so many pieces are ready to fall. Brinksmanship with the debt or even constant threats that it could happen, though it legally cannot, is not a mature way to cut the budget in a time of so many other crises, such as enduring inflation, Fed tightening, collapsing banks, recession reappearing, a stock market that fell for over a year and still hasn’t recovered, resent Covid craziness, a severe labor shortage, and collapsing real estate. These morons are running around in a dynamite factory, swinging blow torches and uncovered cans of gasoline.
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About the author
David Haggith is the publisher/editor-in-chief of The Daily Doom.
Economic, Social and Political News of Our Troubled Times -- a non-partisan daily collection of the most consequential stories about our complex times from multiple sources around the world plus daily editorials like the one you read here.
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