Economics Politics

Economic Consequences of a Federal Government Default

As the odds of a first-time-in-history federal default grow larger, it is worth considering the economic consequences of a default. A default would place at risk up to $160 billion in federal payments just for the month of August. As each billion dollars lost per month translates into jobs for up to 20,000 people, a loss of $160 billion could result in the loss of up to 3.2 million jobs. At a time when the true unemployment rate is nearing 25%, the loss of this many more jobs would likely push our economy over a financial cliff. Here in Washington State alone, the cost is likely to exceed one billion dollars and cause the loss of an additional 20,000 public and private sector jobs. This is on top of the huge State budget cuts that took effect on July 1st. We are reliving history and repeating the mistakes of Hoover Economics in 1931 – which even more than the 1929 Stock Marker Crash – led to the Great Depression.

Here is what others have estimated might be the economic impact of a default:

“The US government is the largest purchaser of goods and services on planet earth. The government buys everything from equipment for cancer research to metal for warships to toothpicks for federal cafeterias. Suppose the government had to cut 44% from its budget on 2 weeks notice? How sharp a shock would that be to the world economy? Here’s a comparative. In the worst quarter of 2009, American consumers cut their spending by … not 44%, not even 4.4%, but 1.2%. That 1.2% drop in consumer spending helped tumble the US economy into the worst collapse since the 1930s. The US consumer sector is even larger than the federal government sector. But it’s not unimaginably larger. US consumers spend about $10 trillion a year. The federal government spends about $3.4 trillion. If a cut of 1.2% from $10 trillion was an economic shock, a cut of 44% from $3.4 trillion will be a much, much, much bigger shock.”

The article then went on to estimate that the shortfall would be about $160 billion per month in reduced federal spending – based on income of $140 billion per month to cover obligations of $300 billion per month.

“Congress’ failure to raise the debt limit in a timely manner would leave the Treasury powerless to borrow money except to refinance maturing securities. With the power to spend only what it collects in revenues, the government would have to cut spending abruptly by over one-third, putting an enormous drag on economic growth at a time when the economy is struggling to recover from the Great Recession. It also would harm millions of businesses, employees, and beneficiaries who rely on timely federal contract, reimbursement, benefit, or other payments.”

 Twenty-nine cents out of every dollar in the Wisconsin state budget comes from the federal government, according to the Department of Administration report describing the potential implications of default on Wisconsin . Top programs with federal support include Medicaid, UW research and financial aid, transportation, Temporary Aid to Needy Families (TANF), child care and child welfare services funding, energy assistance, workforce training, and community development block grants.

If the state does not or cannot provide temporary cash flow assistance to a program, DOA notes it may have to implement a payment prioritization plan. This could have a devastating effect on individuals and businesses that count on the state to meet its obligations. For example, in the Medicaid program – for which the federal government provides $350 million in support each month – stopping payments to providers could force the closure of health care facilities, particularly in rural areas.

 Paychecks for government workers, vendors and state and local governments would likely be withheld or not paid in their normal timely manner, says Vincent Reinhart of the American Enterprise Institute.

 Note that bond holders would be paid, but others would see at least a 30% cut – with some groups possibly seeing a 100% cut.

 The following is from a May 2011 letter by the US Treasury Secretary:

“A broad range of government payments would have to be stopped, limited or delayed, including military salaries, Social Security and Medicare payments, interest on debt, unemployment benefits and tax refunds,” he wrote. Geithner also said there would be higher interest rates and borrowing costs, declining home values and reduced retirement savings for Americans.

 Below is a partial list of what might happen in the event of a default:

  1. $33 billion in Social Security payments scheduled to be mailed on August 3rd might not get mailed.
  2. About $50 billion in federal matching fund payments to the States also scheduled for August might not get made. California recently got a $5 billion private loan guarantee to guard against economic disaster resulting from a default.
  3. Billions in payments to veterans and the disabled might not be made.
  4. About $50 billion in payments to private venders with federal contracts might not be made… causing them to lay off millions of private sector employees.
  5. Ironically, billions in payments on US treasury bonds to the Chinese likely will still be made.. which is why the Stock Market and Bond Market have not fallen significantly.

 Of course, a deal might be reached any day now. Or Obama might use the 14th Amendment which specifically requires him to protect the credit of the United States to unilaterally raise the debt ceiling. But there is no question that if the US did default it would have a huge financial impact in the US and around the world. The clock is ticking. Will the bomb explode?

Originally posted at