Who Gets Stiffed When The Debt Limit Isn’t Raised?

Karl Smith says it’s not a default when a government fails to meet contractual obligations to soldiers:

Contra to Neal Wolin, if bondholders needed sign that under no state of affairs will any credit losses on US bonds ever be allowed, then prioritizing debt payments over the men and women who have shed blood for their country would do it.

If seniors across America start having their chemo cancelled so that Arab Sheik’s get their bond payments on time then US creditworthiness will go through the roof.

This seems like a bit of a metaphysical dispute, but it’s a useful opportunity to shift ground to the question of what actually would happen in case of us reaching the debt ceiling.


This would amount, basically, to the federal government facing a temporary cash flow problem. Markets are willing to buy US debt at interest rates that make it perfectly possible for the Treasury to stay solvent, but congress won’t let Treasury sell the debts. Under the circumstances, incoming cash is insufficient to meet all scheduled obligations. But it’s not zero. And presumably Tim Geithner will keep paying creditors. Social Security has its dedicated funding stream.

How about the rest of the government? Well the real issue here, I think, is what happens if the President tells you that you can’t get paid just now because congress is being difficult, but he’d like you to keep on keeping on anyway. Soldiers in the field aren’t going to mutiny, the Pentagon will just keep track of what back pay they’re owed and families back home will complain to their members of congress. Similarly, the firms the Pentagon contracts with will recognize that the long-term viability of their contracting business is at stake and will keep fulfilling the terms of their contracts in exchange for IOUs. So nobody’s going to run out of bullets. And it seems to me that if you really wanted to, you could generally keep things more-or-less going on this basis. Instead of selling bonds to investors to get the cash needed to finance the government, you could de facto borrow money by giving IOUs to service providers. Financial institutions should be willing to buy the IOUs from their recipients, and then Wall Street will find itself lobbying congress to pay the government’s debts.