Breaching the debt ceiling wouldn't be the end of the world -- at least not right away. If Washington continues to squabble past the October 17th deadline the country could probably hold things together using cash for about a month or so before it had to start making the hard decisions. But if this thing goes on into December, you can just forget about Christmas this year.
Throughout the recent budget debate in Washington, the Republicans have sworn up and down that they would not use the debt ceiling as a bargaining chip to win concessions from the Obama administration. Sure, they would shut the government down, as they did last week, but they wouldn't allow the U.S. to default on its commitments by refusing to raise the debt limit. But this past weekend, House Speaker John Boehner escalated the budget fight saying on ABC's This Week, that "the votes are not in the House to pass a clean debt limit." He followed up, saying that "the president is risking default by not having a conversation with us." On Tuesday President Obama shot back saying that Senate Democrats have tried to discuss the budget with Republicans 19 times this year but were rejected.
It is unclear why the Republicans upped the stakes in their long-standing poker game with the Obama administration. It could be a face-saving move by the speaker to get the administration to agree to smaller budget concessions, so that he wouldn't have to walk away totally defeated. Whatever the reason, the mere threat of a U.S. default caused Wall Street to shiver a bit this week, with stocks taking a dive and Treasury yields edging upwards. On Tuesday the VIX volatility index moved above 20, suggesting that the markets have become officially worried.
It is hard to say for sure what could occur if the government failed to raise the debt limit in time as it has never happened before. Indeed, Congress has successfully voted to raise the debt limit a total of 73 times since it was created in 1917. But with the nation's debt approaching an unsustainably high $17 trillion and with the Republican Party fragmented, the 74th time could be the charm.
So what happens on October 17th and the government has hit the debt ceiling? The Treasury has $30 billion left in its "checking account" and panic roams the streets. Some believe the Treasury could prioritize its spending to pay the more "important" things first and put off less important payments until the government comes to its senses and raises the debt ceiling. For example it may choose to pay veterans benefits but put off paying active duty troops.
But who is to say what is more important? Not the Treasury. It has said that it is illegal for them to pick and choose winners and that they wouldn't do it. In any case, it probably couldn't even do it if it wanted to as the government's check writing machine apparently has no way of differentiating who it is paying and when. It's as if you had 80 million automatic debits in your checking account every single day – it would be hard to stop a thousand of them, but millions? One would think that the government would have a more sophisticated payment network but apparently it just works on autopilot. Luckily, interest payments made to those holding Treasury bonds are on a separate payment system, so in theory the government could prioritize those payments over all others. While it might be illegal or unethical to prioritize interest payments over, say, social security checks to the elderly, it would avoid the nation defaulting on its bonds.
To be sure, the government would technically be in default the second it delays payment to any of its creditors -- whether it be your grandma in Kansas who didn't receive her social security check or the People's Republic of China who didn't receive the interest on its cache of U.S. Treasury bonds. But when Wall Street and the White House say they are worried about a government "default" they aren't thinking about grandma (though they should); rather, they are worried about the markets going haywire and crushing what's left of the so-called "economic recovery." If the U.S. misses an interest payment or two the fear is that the government won't be able to issue more debt at reasonable rates.