The United States government currently has a debt ceiling limit of $14.294 trillion dollars. That limit was technically reached weeks ago, but the Treasury Department has managed to avoid a default by what they call “extraordinary measures.” Treasury Secretary Timothy Geitner has warned that those “extraordinary measures” can only work so long, and that if the debt ceiling is not raised by early August the government will not have the funds it needs to even make interest payments on the debt. Some conservatives, such as leading Republican Rep. Paul Ryan (R-WI), have argued that a default would be a good thing, in that it would force the country to get it’s “fiscal house” in order. However, a default would practically mean an immediate increase in the federal debt which could last for months and possibly even years.
Currently the United States makes very low interest payments on the debt because of our solid credit rating. Much like an individual borrower, the country is able to borrow money for less because the lenders believe we are safe bet to pay back the loan. However, a default would put that credit rating at risk. Credit rating agencies have already warned that they may start re-evaluating America’s credit rating as early as July, before the country actually defaults, if Congress does not increase the debt ceiling by that time.
Talking Points Memo consulted a number of experts on the federal debt and bond market. According to their calculations, a small 1% increase in interest rates would grow the deficit by $400 billion over the next five years and $1.2 trillion over the next ten years. Simply put, a default on the debt would dramatically increase the debt. The debt obligation will still exist, it will merely grow at a much faster rate than if the United States raised the debt ceiling.
In addition, a 1% increase in interest rates may be a fairly conservative estimate of what will happen if the United States defaults. As economist Donald Morran notes, the country accidentally defaulted on some Treasury bills, not the entire debt, in 1979. Congress and the Treasury Department quickly moved to correct the error and start making payments again, but the damage had already been done. Interest rates on the United States debt rose .60% and the bump in rates lasted for many months even though everyone knew thee default was an accident. A purposeful default may have even more severe, long-lasting effects. Talking Points Memo quotes Bill Gross, founder of the bond giant PIMCO, as saying that a default would lead to an “overnight” increase in interest rates of .50% and a plunge in the stock market.
If interest rates go up it will also affect the larger economy. Consumers and businesses will find it hard to obtain financing, and the loans they do obtain will come at more expensive interests costs. Some forecasters believe a default would lead to another severe recession, if not an economic depression. If the economy did falter because of a default, it would also make the federal debt much worse since government revenues would decrease with the smaller tax base.