How Big a Deal Is a Default on the National Debt?
As Congress debates raising the debt ceiling, a B.C. economist offers his perspective on the potential stakes.
With another potential compromise to avert a default on the nation’s debt seeming unlikely, the world is considering with ever more urgency what Congress’s inability to raise the debt ceiling would mean for the economy. While politicians have disagreed, on whether its apocalyptic or no big deal, we asked Boston College professor of macroeconomics and international economics Robert G. Murphy to offer his perspective:
1. Don’t listen to the optimists. A default on the national debt would be a “crisis.”
“I actually lean more toward, not apocalypse, but just a major crisis,” Murphy says.
It’s hard to know how markets will react, he says, but “everything I’ve seen and heard from financial communities, they’re very worried that if we were to default, we’re likely to see some panicked selling. And my guess is the stock market, which has already taken a bit of a hit, I think we’d see a hit there.”
The precedent, too, would have an impact on interest rates. “The fact that we would have not made good, even if it gets patched up quickly, is going to create a risk premium going forward, so that interest rates on securities from then on out would be higher than otherwise. And that filters through to mortgage rates, to consumer loan rates, to credit card rates, etc. So borrowing costs for average consumers, and borrowing costs for businesses, would be higher as a result.”
Transactions between institutions, too, often rely on treasury bonds as a stable investment that can be transfered between parties. But if its no longer seen as stable, institutions might not accept them as collateral, which might slow down credit.
2. Treasury can’t necessarily maneuver us into paying the most important bills in order to stave off disaster.
“There’s been this discussion that we could prioritize payments so that we wouldn’t technically be defaulting,” Murphy says, alluding to suggestions that Treasury prioritize spending so that we pay our debtors and choose other programs to leave unfunded until we sort out our borrowing situation. “Well, technically we wouldn’t be defaulting, but I think effectively we would because these other obligations are things that are mandated spending that’s required by law.”
“Effectively it would be the same for the markets, who would view this as something that’s not sustainable and there’d be the same fallout.”
3. The shutdown and the prospect of default have already harmed the economy, but not as badly as would actual default.
Confidence, Murphy says, is already hurt by the wrangling in Washington. “Anybody that’s in the situation right now of thinking of hiring more workers or going ahead with some new capital investment project for their factory or business is going to put things on hold. Let’s wait until this gets things resolved.”
As for the shutdown, “people would have gone to national parks and stayed or eaten at restaurants. That’s not going to happen. Some of that might be postponed but some of that is gone. I think we’re clearly having some restraining effects right now, and the longer that goes, the shutdown itself, that affects the economy. But the debt ceiling itself is a much bigger fear.”
4. Other countries think we look silly.
“I would guess outsiders are just kind of astounded. And also the debt ceiling isn’t a thing other countries have to contend with it.”
An outsider also might not understand why a debate over health care has bled over into a crisis on paying our debt.
“At least in ’95-’96, you could point to the fact that Gingrich and his folks were interested in balancing the budget, bringing the deficit down, cutting spending. It was tailored toward the fiscal side. This time around it’s these ideological policy issues getting dragged into it like health care.”
5. The most important thing at stake here is the precedent that we might not pay our debts.
If we set a precedent by telling people that we’re not always good for our debt, Murphy says, it will have a huge impact on the attitude with which people view our bonds.
“There was a lot of discussion about Revolutionary War debt that had been accumulated … And when we were starting fresh in 1789, there were voices that said, ‘Let’s repudiate that debt. Let’s start fresh. The legacy of past is gone.’ And Alexander Hamilton, who was the Treasury Secretary under George Washington, was adamantly opposed to anything like that. And his point was, ‘If you do that now, it ruins our credibility going forward.’”
“I think that decision set the tone that we will, going forward, not ever think about that. And I don’t want to go there. I don’t want to find out what the consequences ultimately are for the future.”