Congress's Blueprint for Global Catastrophe

The global economy faces a bizarre man-made threat: Radical legislators in the U.S., issuer of the world’s most trusted currency, think forcing the government to renege on its obligations is a good way to shock it into recognizing the error of its fiscally imprudent ways.

Lest anyone take this notion seriously, here’s what would happen if that threat were carried out. To keep spending, the government needs Congress to pass a spending law. Republicans have already blocked this—holding the budget hostage to defunding Obamacare, a settled law—resulting in a partial government shutdown. Now they’re threatening the separate and much more disruptive step of refusing to raise the federal debt ceiling, currently set at $16.7 trillion. Spending exceeds revenue; without permission to borrow more, the government won’t be able to pay its bills even if a law allowing spending goes through. If the debt ceiling stays in place, the Treasury will run short of cash soon after Oct. 17. At that point …

1. Global markets will see the U.S. government as grossly and dangerously incompetent. Refusing to raise the debt ceiling is fundamentally different from cutting the government’s funding. It’s as if Congress were sending the Treasury two contradictory and legally binding orders: one that requires it to make hundreds of billions of dollars a month in payments and another that prevents it from borrowing the money it needs to do so. Which order is the Treasury supposed to obey? This is the stuff of absurdist theater. Confidence matters, and an event like this will destroy confidence.

2. Forced spending cuts will kill the economic recovery. Over the course of a year, the Treasury borrows roughly $1 out of every $5 it spends, so hitting the debt ceiling would require it to cut outlays by about a fifth—and by much more in the short term, because flows into and out of the Treasury are lumpy. Such a severe fiscal squeeze would crush a still-tentative recovery at a time when widespread unemployment is threatening to do permanent damage to the country’s productive capacity.

3. The U.S. government might actually default on its debts. Some in Congress apparently believe that hitting the debt ceiling doesn’t necessarily mean the government will miss a payment on its $12 trillion in bonds outstanding—an event that markets would call a default, which could trigger a financial catastrophe (see No. 4). The House of Representatives has passed legislation to authorize the Treasury to prioritize such payments.