People today are talking about the possibility of the U.S. government going bankrupt. It might sound like a great exaggeration, but it isn’t. Strictly speaking, a national government can’t go into bankruptcy, but that is a technical legal distinction that we can leave to the lawyers. All that distinction really means is this: the federal government’s “bankruptcy,” if it were to happen, won’t be decided by a bankruptcy judge, but by the White House and Treasury and, to the extent that it chooses to get involved, Congress.
When is the federal government effectively bankrupt? It has never happened, but if it were to happen, it would happen the day the government hit the statutory debt ceiling. The way things are going, this would happen six to eight weeks from now. Congress can, of course, intervene by raising the debt ceiling, but not everyone in Congress wants to keep the federal government out of bankruptcy.
You see, if the government is in bankruptcy, it will force the White House to cut government spending, and not just by a little, but by about a third, instantly. Some people think it’s the only way to stop the government’s spending spree. Suddenly there wouldn’t be so much money for health care, unemployment compensation, workplace safety, Social Security, border security, public employee salaries, and all the other things that small-government conservatives have been trying to chip away at.
But it wouldn’t stop there. Interest payments on government debt would stop immediately. That’s the part that has Wall Street calling the scenario “Armageddon.” Treasury bonds would be junk bonds, insurance companies, pension funds, money market funds, banks, and individual retirees would be wiped out left and right, the stock market would crash, there would be a run on the largest banks, and the barter economy would make a comeback among people who suddenly had no access to money in any form. With no money for fuel, the military would at least have to park its submarines and airplanes. City buses and subways might have to park too. “Armageddon” is an exaggeration, but a fitting one.
And it is not that the country can completely avoid these consequences if Congress raises the debt ceiling at the last minute. Just by getting as close to the edge as we have already come, the United States has lost some of its financial credibility, which means more of the budget will go to interest payments and less to government services. Treasury bonds could turn into junk bonds a week or two before the debt ceiling deadline — and if they do, their previous investment-grade status may not come bank for years. And there is still the problem of the federal budget, which has to be brought back down to some semblance of sustainability by next year, regardless of debt ceiling or interest rates.
You are sure to hear from a majority of experts along the way that it isn’t possible for the United States to go bankrupt. What they’re really saying is that it’s unthinkable for the federal government to put itself into the painful financial state of not being able to meet its obligations. But as we have seen many times in the last five years, “unthinkable” doesn’t mean that something won’t happen.